Page 1

Multigenerational Wealth Management t

The critical first step in planning: Calculating the senior generation’s lifetime spending needs

t

How to enhance family wealth by allocating assets within a multigenerational framework

t

The advantages of quantitative modeling in building an optimal wealth transfer strategy

t

The estate planning risks that early mortality poses and how to hedge against them

t

Why all wealth transfer plans should be flexible enough to evolve as circumstances change

LWI Management Research Mar c h 2010


This research paper is one in a series produced by Leader World Investments Group on issues of particular significance to investors of means and their professional advisors.

LWI does not provide tax, legal, or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions. Leader World Investments, LLC McAllen | New York | London ŠMarch 2010, Leader World Investments. . All rights reserved.


Table of Contents

Significant Research Conclusions

1

Introduction: Navigating the Multigenerational Headwinds

3

Enough Already: Quantifying Core Capital

5

Sizing, Segmenting, and Allocating Excess Capital

10

Optimizing Wealth Transfer: At the Right Pace, at the Right Time

15

Gifts, GRATs, and IDGTs: The Bedrock of Multigenerational Wealth Transfer

18

The Mortality Gap: What if Death Intervenes?

28

Building on Bedrock for Generations to Come: Multigenerational Solutions

32

Implementing, Monitoring, and Adjusting the Plan

40

Appendix

44


Significant Research Conclusions

Once a family has significant wealth, the problem becomes how to preserve it for future generations—a surprisingly difficult task. Effective multigenerational wealth management requires a family to tackle the personal issues that determine who should benefit from the wealth, the tax hurdles that stand in the way of its efficient transfer, and the capital markets uncertainties that make it challenging to invest it prudently. We’ve developed new research capabilities designed to help families cut through the complexity and identify the solutions most likely to meet the needs of all the generations and charities they’d like to benefit.

5IJTCPUUPNVQBQQSPBDIUPBGBNJMZTBTTFUBMMPDBUJPO‡CVJMEJOHUIFNJYHFOFSBUJPOCZHFOFSBUJPO‡ can materially enhance overall wealth without QVUUJOHUIFTFOJPSHFOFSBUJPOTMJGFTUZMFBUSJTL

Our enhanced Wealth Forecasting System marries quantitative capital markets modeling with estate planning techniques to help us analyze the many complexities that multigenerational wealth presents. By providing a framework that systematically “stress-tests� potential solutions, the model offers the senior generation and their professional advisors a better understanding of the range of wealth outcomes for each beneficiary, the trade-offs that must be made, and the overall dollar savings that can be realized.

After the various portfolios are sized and invested, the senior generation should use one or more transfer strategies to move their excess capital to their desired beneficiaries in a tax-efficient manner, in the right proportions, and at the right speed.

The first step in multigenerational wealth planning should be to disaggregate family wealth into “core� and “excess� capital. This will drive a family’s decisions about both asset allocation and wealth transfer.

r 5IFTFOJPSHFOFSBUJPOTiDPSFDBQJUBMu‡UIF minimum amount they need to maintain their MJGFTUZMF‡TIPVMECFJOWFTUFEJOBCBMBODFENJY of traditional, liquid assets. r 5IFJSiFYDFTTDBQJUBMu‡BOZXFBMUIJOFYDFTT PGUIFJSDPSFDBQJUBM‡TIPVMECFFBSNBSLFEGPS future generations and charities and allocated in a fashion that matches the risk profile, time horizon, and needs of those beneficiaries.

We’ve found that many families can achieve most or all of their wealth transfer objectives using only a mix of basic gifts, intentionally defective grantor trusts (IDGTs), and grantor retained annuity trusts (GRATs).

r #ZVTJOHUIFTFTUSBUFHJFTJODPODFSU NPTUJOWFTtors can move all of their excess capital out of their estates during their lifetimes while still maintaining ample flexibility to stop or change the course of wealth transfer at any time. The key is scaling the amount committed to a “rolling� GRAT strategy up or down to meet the family’s objectives. r *OBEEJUJPOUPNPWJOHXFBMUIUPDIJMESFO CBTJD HJGUTBOE*%(5TDBOQBTTBTVSQSJTJOHBNPVOU to grandchildren and more remote descendants transfer-tax-free. r Moreover, with enough time, “intergenerational� GRATs—wherein wealth is moved from one generation to the next, and the one following, using rolling GRATs— can be a more efficient way of moving assets to distant descendants than other commonly used strategies.

(continued, following page) Multigenerational Wealth Management: Getting a Legacy Up

1


Many families will have specific objectives or challenges that require other wealth transfer strategies. Our Wealth Forecasting System can help determine: r 8IFOBEEJOHMJGFJOTVSBODFUPBNVMUJHFOFSBtional wealth plan may be desirable, and how to determine the right death benefit; r )PXJOTUBMMNFOUTBMFTUP*%(5TGBSFJOUSBOTGFSring wealth to grandchildren or more remote descendants; and

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Bernstein Wealth Management Research

r )PXBDIBSJUBCMFHJWJOHQSPHSBN UISPVHIUIF use of a private foundation, can add financial value for the family and charity, and provide a platform for instilling the virtues of charitable giving in future generations. Our quantitative forecasting tool provides a framework for families and their advisors to dimension their decisions, move forward with a sound plan, and adjust it over time as markets and their own circumstances change. â–


Multigenerational Wealth Management Getting a Legacy Up

Riches very seldom remain long in the same families. Adam Smith

INTRODUCTION: NAVIGATING THE MULTIGENERATIONAL HEADWINDS

Since then, things have gotten little better. Research shows that about 60% of wealthy families exhaust the greater part of their estate by the second generation; by the third, nine out of 10 family fortunes are gone.1 5IFIFBEXJOETDBOCFĂŞFSDF Display 1 "GBNJMZT fortune can decline quickly due to lax oversight, spendthrift descendants, or rapidly expanding spending requirements, as a growing pool of beneficiaries DPNFTPGBHFBOEMPPLTUPUBQJOUPUIFXFBMUI 5IF number of descendants typically doubles with each HFOFSBUJPO 5IFOUIFSFTUIFQSPTQFDUPGQPPSJOWFTUment returns or steady erosion from inflation, which JNQPTFTBESBHPOUIFBTTFUTFWFOBTJUTXFMMTBGBNJMZT TQFOEJOH"OEĂŞOBMMZ UIFSFTUIFNPTUJOKVSJPVTCMPX PGBMMFTUBUFUBYFT BMFWZUIBUDBOIBMWFBGBNJMZT wealth in one fell swoop. The Anxiety of Affluence

Equally important as these economic concerns are the difficult emotionalJTTVFTGBNJMJFTGBDF5IFTFJODMVEF deeply personal questions, such as who the primary beneficiaries of the wealth should be, how fast the wealth should be moved to those beneficiaries, and whether the wealth will spoil younger generations or create conflict or resentment among family members. Further, the senior generation must determine what safeguards they need to put in place to ensure that the

Display 1

Multigenerational wealth faces stiff headwinds Family Wealth After Spending, Taxes, and Inflation

Estate taxes Wealth

Among the many economic questions explored by Adam Smith, the “father of capitalism,� was whether family wealth could last over successive generations. )JTDPODMVTJPO%FTQJUFUIFCFTUPGJOUFOUJPOT GBNily fortunes rarely survive the crossing.

Poor investment choices; high inflation Expanded set of beneficiaries Today

Number of Beneficiaries

10

10

20

Years

30

40

20

50

40

Source: AllianceBernstein

funds are spent responsibly and to retain enough flexibility so they can adjust their wealth transfer plans if UIFJSDJSDVNTUBODFTPSEFTJSFTDIBOHF5IFOUIFSFTUIF RVFTUJPOPGUIFJSDIBSJUBCMFMFHBDZ*GUIBUTBOJNQPStant goal, they must decide on the timing and size of those gifts. Professionals in the worlds of finance, law, and accounting stand ready with a broad range of strategies designed to help families navigate these choppy waters. But at times it seems as if the sheer array and comQMFYJUZPGBMUFSOBUJWFT‡UIFNZSJBEUSVTUT DIBSJUBCMF strategies, and insurance vehicles, and the ever-lengthening list of publicly traded asset classes, private funds, DPMMFDUJCMFT BOEPUIFSJOWFTUNFOUT‡DBODBVTFFWFOUIF most well-intentioned families to freeze in their tracks.

1 Perry Cochell and Rodney Zeeb, Beating the Midas Curse (Heritage Institute Press, 2005)

Multigenerational Wealth Management: Getting a Legacy Up

3


Display 2

Quantitative modeling can help families navigate the way to an optimal solution Senior Generation’s Wealth

Children’s Wealth

Grandchildren’s Wealth

Transfer Objective

Charity Transfer Objective

Transfer Objective

Wealth

Total Estate Today

Core Capital

Today

The Last Day

In the Future

Today

In the Future

Today

In the Future

Steps t Ensure that the senior generation can always maintain their lifestyle t Disaggregate family wealth into pools of capital according to its intended uses t Allocate each pool to meet the needs of the beneficiaries for whom it is intended t Identify tax-efficient ways to move the wealth to the intended beneficiaries t Share funds with beneficiaries at the right time, in the right amount t Monitor and adjust the plan over time

Source: AllianceBernstein

Quantifying and Optimizing the Alternatives

5IFQVSQPTFPGPVSSFTFBSDIJTUPIFMQTJNQMJGZUIJT process, using quantitative analysis to take some of UIFĂŞOBODJBMHVFTTXPSLPVUPGUIFQMBOOJOH8FWF created a framework that first disaggregates family wealth into appropriate generational “bucketsâ€? to allocate and grow the funds in accordance with UIFSJTLQSPĂŞMFTPGUIFVMUJNBUFCFOFĂŞDJBSJFT5IF framework then helps to identify an appropriate mix of transfer strategies to move the assets in a taxefficient manner to younger generations and charity. Key to our research is a series of enhancements XFWFNBEFUPPVSQSPQSJFUBSZ8FBMUI'PSFDBTUJOH4ZTUFN5IFTFFOIBODFNFOUTDBOIFMQBGBNJMZ and its professional advisors construct a plan that enables the senior generation to be confident that they can both maintain their lifestyle and move UIFJSXFBMUI‡POUIFJSPXOUJNFUBCMFBOEJOBUBY FÄ…DJFOUBOEUBSHFUFENBOOFS‡UPUIFJSJOUFOEFE beneficiaries (Display 2 5IFQPUFOUJBMCFOFĂŞUT  both in terms of dollars and cents and peace of mind, are huge.

Specifically, our planning approach should help families and their professional advisors determine: r The amount of funds that the senior generation must retainUPNFFUUIFJSMJGFTUZMFOFFET‡XIBUXFDBMM their “core capitalâ€?; r The “excess capitalâ€? they have available to give during their lifetimes to descendants or philanthropic causes without jeopardizing their financial security; r The optimal allocation for these two pools of capital, SFĂŤFDUJOHFBDIQPPMTVOJRVFQVSQPTFBOEUIF GBNJMZTQSJPSJUJFT r A method for optimizing among the array of wealth transfer strategies to determine how best to move the wealth to the desired beneficiaries, at the right time and in the right proportions; r The appropriate pace of lifetime wealth transfer, showing the benefits and costs of differing rates of transfer and how to mitigate the risks of early mortality; and r A framework for monitoring and revisiting the plan, as markets, tax laws, and family circumstances change. *OUIFSFTFBSDITUVEZUIBUGPMMPXT XFBEESFTTFBDI of these issues in turn. â–

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Bernstein Wealth Management Research


ENOUGH ALREADY: QUANTIFYING CORE CAPITAL

I have enough money to last me the rest of my life, unless I buy something. Jackie Mason

Break It Down to Build It Up: Disaggregating Family Wealth

One of the most formidable obstacles to successful multigenerational planning is the natural tendency of the senior generation to view their wealth as, XFMM UIFJST5IBUJT UIFZUIJOLPGJU BOEBMMPDBUF JU BTJGJUTQBSUPGBTJOHMFQPSUGPMJP‡UIFJSPXO Families with multigenerational goals, however, can gain tremendous advantages by disaggregating the XFBMUIBDDPSEJOHUPJUTJOUFOEFEVTFT‡TQFDJêDBMMZ  UIFJOEJWJEVBMTBOEDIBSJUJFTJUTVMUJNBUFMZNFBOU UPCFOFêU"TXFMMTIPX CZDPODFQUVBMJ[JOHUIFJS wealth in this fashion, the senior generation can better craft a strategy to build and preserve the famiMZTXFBMUIPWFSUJNF 5IFêSTUBOENPTUJNQPSUBOUTUFQJOre-visioning UIFGBNJMZTXFBMUIJTUPRVBOUJGZUIFTFOJPSHFOFSBUJPOTiDPSFDBQJUBMu‡UIFBNPVOUUIFZOFFEUP cover their personal spending for as long as they live (Display 3). Since investors need to meet their core needs even in dismal markets, we focus on very high

levels of confidence that their money will last. For some, this portfolio for life may also include a rainyEBZGVOE‡BTFQBSBUFSFTFSWFGPSNFEJDBMPSPUIFS life emergencies or for some potential new business venture. Regardless, the core capital figure is the cornerstone for all the planning that follows because it gives the senior generation both financial security, since it is quantified using very conservative assumptions, and flexibility, since it lets them know the amount of “excess capital� they have available.2 Because excess capital has a purpose distinctly different from core capital, these pools of assets should be managed differently. Core capital, for example, should be invested conservatively, to ensure that it will always be sufficient to meet the senior HFOFSBUJPOTMJGFTUZMFOFFET FWFOJGUIFZFODPVOUFS extremely hostile markets. Excess capital, on the other hand, should in most cases be invested more aggressively, and can be safely moved out of the TFOJPSHFOFSBUJPOTFTUBUFT TJODFUIFMPTTPGUIFTF BTTFUTXPOUKFPQBSEJ[FUIFJSMJGFTUZMF

Display 3

Defining core and excess capital is the first step Goals for Wealth

Allocation Strategy

Lifestyle Spending

t

Invest for security

t

Balanced mix of liquid, traditional asset classes

t

Invest more aggressively

Core Capital Emergency Reserve

Transfer Strategy t

Minimum amount that must always remain in the estate

Children Grandchildren GreatGrandchildren

Excess Capital

t Tailor

allocation to the risk profile of the beneficiaries

t Amount

that can safely be transferred out of the estate

Charity Source: AllianceBernstein

2 In discussing the value of envisioning one’s wealth as composed of separate “pools� or “buckets� (e.g., for core and excess capital, or within excess capital, separate pools for each

individual beneficiary), we are speaking conceptually, not literally. We do not mean to imply that the funds must always be set aside or moved into a special account or trust. These buckets are simply a way in which an investor can better analyze these sums, so that he or she can develop an optimal asset allocation and wealth transfer plan.

Multigenerational Wealth Management: Getting a Legacy Up

5


5PEFUFSNJOFUIFTJ[FPGUIFDPSFDBQJUBM XFNVTU determine the rate at which an investor can safely spend without ever needing to cut back.3 Once we arrive at this “sustainable spending rate,â€? we can determine the amount the investor needs to maintain his spending. While that process may sound simple, it requires a rigorous forecasting tool that takes into account the vagaries of the capital markets, inflation, taxes, and investor longevity. By simulating 10,000 plausible PVUDPNFT‡GSPNTVQFSJPSUPEJTNBM‡GPSUIFDBQJUBM NBSLFUTBOEJOĂŤBUJPO BTXFMMBTJOWFTUPSMJGFTQBOT‡ CPUIMPOHBOETIPSU‡XFDBOTUSFTTUFTUUIFQPSUGPMJPUPNBLFTVSFJUTCVJMUUPMBTUBUMFBTUBTMPOHBT the investor himself.4 *ODisplay 4, we show our estimates of the “life spanâ€? of a portfolio invested in a globally diversified 60% stock/40% bond mix, assuming annual spendJOHSBUFTUIBUSBOHFGSPNUP*ORVBOUJGZJOH BOJOWFTUPSTDPSFDBQJUBM XFXBOUUPFOTVSFUIBU he can maintain his spending even in very difficult markets. For that reason, we start by focusing on the number of years an investor can spend with a very high level of confidence‡IFSF UIFUIQFSDFOUJMFPG probability from the 10,000 projections we model of capital markets returns and inflation. 5IFEPXOXBSETMPQJOHMJOFPOUIFEJTQMBZTIPXT that an investor who spends 3% of the initial value of his portfolio (and increases his spending annually with inflation) could sustain that spending for 38 years. By increasing the spending rate to 4%, the JOWFTUPSMPTFTBCPVUBUIJSEPGUIFQPSUGPMJPTMPOHFWJUZ BOEDPVMETVTUBJOIJTTQFOEJOHGPSPOMZBCPVU years under extremely challenging capital markets conditions and high inflation. Raise the spending rate to 6%, and even more time is taken off the

Display 4

How long will it last? Gauging a portfolio’s longevity Years That Spending Can Be Sustained in Hostile Markets* 60% Stocks/40% Bonds 50

Sustainable After-Tax Spending Rate (Mortality-Adjusted)

40 Years

Covering Your Assets: A Portfolio “For Life�

38

Age 55

Age 65

Age 75

3.0%

3.5%

4.4%

30

25 19

20

15 10 3%

4%

5%

6%

Annual Spending Rate (% of Initial Portfolio Value)†*Results at the 95% level of confidence †Grown with inflation Unless stated otherwise, throughout this book we assume that stocks are globally diversified (35% US value, 35% US growth, 25% developed foreign markets, 5% emerging markets) and bonds are intermediate-duration municipal and taxable securities (held in taxable and tax-exempt accounts, respectively), and we assume that taxes are levied at the highest marginal federal bracket and state income tax is 6%. Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48–49, for further details.

DMPDL MFBWJOHKVTUZFBSTPGTVTUBJOBCMFTQFOEJOH with a high degree of confidence. *GXFPWFSMBZUIFQSPCBCJMJUJFTGPSJOWFTUPSMPOHFWJUZ onto our analysis, we can identify the safe spending rate that a couple could sustain for as long as they live (see Display 4, inset). For example, we estimate UIBUBZFBSPMEDPVQMFDPVMETBGFMZTVTUBJOB spending rate. A couple 10 years older, however, could spend at a higher rate because their time horizon is shorter.8FEQFHUIFJSTVTUBJOBCMFSBUF BUBQQSPYJNBUFMZ"OEBDPVQMFZFBSTPME could spend as much as 4.4% of their initial assets.

3 Unless otherwise indicated, a “spending rate� in this study means a percentage of a portfolio’s initial value, grown with inflation. For example, an investor who has $10 million

and spends at a 5% rate would withdraw $500,000 the first year, increasing the amount withdrawn annually for inflation. We assume that all spending is net of any applicable taxes (see Notes on Wealth Forecasting System, pages 48–49). 4 Real life is messy, and in actual practice there are typically a host of idiosyncratic elements in any core capital analysis. For example, in many cases our Wealth Forecasting System also needs to take into account an investor’s other income, which may vary over time (e.g., pensions that last only for a specific period, or a one-time stock option exercise), as well as certain expenses that change over time (e.g., tuition payments that will end or a one-time home remodeling project). 5 Although perhaps not as short as some would guess: There’s a 50% chance of at least one member of the couple living beyond age 92.

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Bernstein Wealth Management Research


Display 5

Age and spending determine the size of the core capital Sustainable After-Tax Spending Rate in Hostile Markets* Mortality-Adjusted Age Spending Rate

50

55

60

65

70

75

80

85

2.8%

3.0%

3.2%

3.5%

3.9%

4.4%

5.1%

6.0%

$ 4.5 Mil.

$ 3.9 Mil.

$ 3.3 Mil.

Core Capital Amounts

Annual Spending

(60/40 Allocation)

$200,000

$ 7.1 Mil.

$ 6.7 Mil.

$ 6.3 Mil.

$ 5.7 Mil.

$ 5.1 Mil.

$300,000

10.7

10.0

9.4

8.6

7.7

6.8

5.9

5.0

$400,000

14.3

13.3

12.5

11.4

10.3

9.1

7.8

6.7

Spending Needs:

$500K

$500,000

17.9

16.7

15.6

14.3

12.8

11.4

9.8

8.3

á Spending Rate:

3.2%

$750,000

26.8

25.0

23.5

21.4

19.2

17.0

14.7

12.5

= Core Capital:

$15.6 Mil.

$1.0 Mil.

35.7

33.3

31.3

28.6

25.6

22.7

19.6

16.7

$1.5 Mil.

53.6

50.0

46.9

42.9

38.5

34.1

29.4

25.0

Example: 60-Year-Old Couple

*Spending is grown with inflation; spending rates assume maintaining spending with a 95% level of confidence. Based on Bernstein estimates of the range of returns for the applicable capital markets over the periods analyzed. Data do not represent past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System, pages 48–49, for further details. All information on longevity and mortality-adjusted investment analyses in this study are based on mortality tables compiled in 2000. Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

What’s Your Number?

How Does Asset Allocation Affect Core Capital?

Display 5 provides a simple method for converting these sustainable spending rates into the amount of core capital that a couple needs. At the top of the display are the maximum after-tax annual spending rates for couples of different ages. On the left are different levels of spending, which we assume XJMMHSPXXJUIJOĂŤBUJPO5IFQPJOUXIFSFBHF and spending level intersect shows the amount we estimate the couple must have to maintain their TQFOEJOHVOUJMUIFTVSWJWPSTEFBUI XJUIB degree of confidence.

5IFHVJEFMJOFTJOUIFBCPWFHSJEBSFCBTFEPOB globally diversified 60% stock/40% bond mix. So would investors with different asset allocations have materially different core capital requirements? Perhaps surprisingly, the answer is that regardless of XIFUIFSBOJOWFTUPSTQPSUGPMJPJTTUPDLPSJFOUFEPS CPOEPSJFOUFE IJTDPSFDBQJUBMSFRVJSFNFOUXPOU materially differ, as long as the portfolio is well diversified.

For example, a 60-year-old couple whose spendJOHOFFETBSF BZFBSTIPVMETFUBTJEF NJMMJPOPGDPSFDBQJUBM5IFZSFSFMBUJWFMZZPVOH and will need a very large portfolio. But as they age, the amount of core capital they require declines; so XIFOUIFZSFBDIBHF UIFZMMOFFENJMMJPO BTQFOEJOHSBUF "UBHF UIFJSDPSFDBQJUBM GBMMTUPNJMMJPO6

5PJMMVTUSBUFUIJT TVQQPTFBOJOWFTUPSTQFOEJOHBUB 4% rate is considering how to allocate his assets. We find that, in poor markets, he can count on about 26 years of spending, provided the assets are invested somewhere in the range of 20% stocks/80% bonds to 60% stocks/40% bonds (Display 6, page 9; see also page 44 of the Appendix for our projected core capital amounts calculated at different asset allocations). On the other hand, if the portfolio is very heavily concentrated in equities, has a large single-stock position, or has a significant commitment to nontraditional

6 These guidelines are for couples. For a single individual, our core capital estimates would differ (the odds of at least one of the two living longer than a single individual are

higher) and would vary based on the gender involved (women have longer life expectancies than men). For a table indicating core capital amounts for individuals, male and female, see the Appendix. Also note that, within each age category, there’s a rather simple, linear relationship among all the amounts: Double the spending and you double the core capital. These numbers, and all those that follow in this study, have been adjusted for inflation.

Multigenerational Wealth Management: Getting a Legacy Up

7


5PCFHJOXJUI UIFXFBMUIPGUIJTUZQFPG investor is concentrated in a particular asset or asset class (e.g., a business or real estate), which increases his risk. Moreover, the investor may be highly averse to selling the asset for a variety PGSFBTPOT)FNBZFYQFDUJUUPDPOUJOVFUPCF more profitable than alternative investments, JUNBZCFIJTMJGFTXPSLBOEQSPWJEFIJNXJUI important emotional benefits, or it may be a family business that he wants to preserve for his children or employees. And an investor whose wealth is concentrated in an illiquid asset may also be forced to face future “capital calls� to meet debt payments, withstand challenging business or economic cycles, or invest in growth opportunities. -FUTUBLFUIFFYBNQMFPGBGBNJMZXJUITJHnificant real estate holdings, the total value of XIJDIGBSFYDFFETUIFJSMJRVJEQPSUGPMJP*OUIJT case, our approach is to determine the amount of liquid reserves needed to address their goals and the specific risks of their illiquid holdings (see display above 5IFMJGFTUZMFSFTFSWFJTNFBOU to ensure that the senior generation can always maintain their spending, without selling assets, even if the cash flows generated by the real FTUBUFEJTBQQPJOUJOUIFWFSZMPOHUFSN5IF real estate reserve ensures that enough capital is available to protect against a sudden short-term downturn in the rental markets or a sudden seizure of the credit markets. And finally, an estate tax reserve helps ensure that the untimely EFBUITPGUIFTFOJPSHFOFSBUJPOEPOUGPSDFB sale of the property to fund that tax bill.

8

Bernstein Wealth Management Research

Core Capital

A Closer Look: Core Capital for Holders of Illiquid Assets %FUFSNJOJOHBOJOWFTUPSTDPSFDBQJUBMJTSFBQuantifying core capital for real estate investors sonably simple when his assets are primarily MJRVJE)PXFWFS NBOZXFBMUIZJOWFTUPSTIBWF Liquid Allocation Assets Role Driver NPTUMZJMMJRVJEBTTFUT‡GPSFYBNQMF BGBNily business or substantial real estate holdings. Investor Lifestyle Supplement spending in case of Risk Quantifying core capital for an investor with Reserve poor long-term real estate returns Tolerance significant illiquid assets requires an approach Duration of Real Avoid forced sales in poor market that differs from our traditional advice. Real Estate Estate Reserve

and financing environments

Estate Tax Ensure liquidity to meet estate Reserve tax liability Excess Capital

Enable legacy goals

Liabilities Time Horizon

Beneficiary Risk Tolerance

Source: AllianceBernstein

For each reserve, there is a corresponding SBUJPOBMFGPSJUTBMMPDBUJPO5IFMJGFTUZMFSFTFSWF must have enough growth potential to outQBDFUIFTFOJPSHFOFSBUJPOTTQFOEJOH XIJDI will increase with inflation, yet it must be consistent with their risk profile, including their BCJMJUZUPFOEVSFQBQFSMPTTFT5IFSFBMFTUBUF reserve is largely tied to the schedule of debt repayment, so it would be primarily or exclusively in bonds, the duration of which should reflect those liabilities. And the allocation for the estate tax reserve would depend on a number of variables, including time horizon: 5IFQSPTQFDUPGHSFBUFSMPOHFWJUZBSHVFTGPSB higher proportion of stocks; a shorter horizon suggests more bonds. 5PHFUIFS UIFTFSFTFSWFTDPOTUJUVUFUIFUPUBMDPSF QPSUGPMJP"OZUIJOHUIBUSFNBJOT BOEUIBUXPOU be plowed back into the business itself, can be considered excess capital. (For a more extensive discussion of this reserve framework for real estate investors, see our recent publication Commercial Real Estate: From the Ground Up.) â–


Display 6

Display 7

Increasing equity concentration could augment your excess in typical markets‌

‌but at the cost of higher volatility The Odds of a 20% Peak-to-Trough Decline over 20 Years*

Years That Spending Can Be Sustained 4% Annual Spending Rate*

Traditional Stock/Bond Mix

95%

50+

50

Typical Marketsâ€

45 39

40 Years

Concentrated Mix

32 30

26

24 20

23 40% Hedge Funds

26

32%

25

23

18 40% Single Stock

20

Poor Marketsâ€

20/80

10 0/100

20/80

40/60 60/40 Stocks/Bonds

80/20

<2%

100/0

*Grown with inflation, after taxes â&#x20AC; â&#x20AC;&#x153;Typical marketsâ&#x20AC;? represent results at the 50% level of confidence; â&#x20AC;&#x153;poor marketsâ&#x20AC;? in this example represent results at the 95% level of confidence. Hedge funds are assumed to be 50% long/short equity funds with high volatility, and 50% market-neutral funds. Portfolios with hedge funds are 30% globally diversified equities, 30% fixed income, and 40% hedge funds. Single stock has a beta of 1.0, volatility of 40%, and a dividend yield of 1.5%; the mix of the remainder of the portfolio is assumed to be 40% globally diversified equities and 60% intermediate-term municipal bonds. Based on Bernstein estimates of the range of returns for the applicable capital markets over the next 50 years. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: AllianceBernstein

investments (such as hedge funds), the odds grow that the portfolio will fail to generate enough years of spending.(FOFSBMMZTQFBLJOH UIFNPSFDPOcentrated the portfolio, the greater the risk that it XJMMSVOESZ*OPUIFSXPSET families with concentrated portfolios need a larger amount of core capital. For most, the crux of the asset allocation decision for the core portfolio hinges on how an invesUPSCBMBODFTIJTEFTJSFUPJODSFBTFUIFQPSUGPMJPT growth potential with a greater allocation to equities (increasing the odds that the portfolio will outlive

6% 40/60

60/40

40% Single Stockâ&#x20AC;

*The chance of losing 20% or more over any period in the 20-year time frame, measured from the point of greatest wealth to least. â&#x20AC; Single stock has a beta of 1.0, volatility of 40%, and a dividend yield of 1.5%; the mix of the remainder of the portfolio is assumed to be 40% globally diversified equities and 60% intermediate-term municipal bonds. Based on Bernstein estimates of the range of returns for the applicable capital markets over the periods analyzed. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: AllianceBernstein

him, with the extra, unused spending years translating into more wealth for his beneficiaries) versus his desire to reduce short-term volatility with a greater allocation to bonds. As Display 6 shows, a 60/40 stock/bond allocation produces at least 10 more years of spending than a 20/80 mix in typical markets.8)PXFWFS JUBMTPQSPEVDFTNPSFWPMBUJMJUZ a three-out-of-10 chance of experiencing a 20% or greater decline in wealth at some point over a 20-year period (Display 7 ). And when a large part of the portfolio is made up of a single-stock posiUJPO UIFEPXOTJEFSJTLJTFWFOHSFBUFS*OTIPSU UIF allocation decision is highly personal: One investor NBZGFFMUIBUIFTBMSFBEZHPUFOPVHIBOENBZXBOU a low-volatility portfolio for the peace of mind it affords, while another may find the likely additional growth appealing. â&#x2013;

7 Although it may be appropriate for an investor to have some exposure to hedge funds or private equity in her core portfolio, such exposure should generally be minimized because

the returns of such assets are much less certain. For example, the returns of a hedge fund are heavily dependent on manager skill, or â&#x20AC;&#x153;alpha,â&#x20AC;? which is less reliable than the returns of traditional asset classes, which are tied more closely to broad market movements, or â&#x20AC;&#x153;beta.â&#x20AC;? For more on these topics, see our analyses of hedge fund returns and single-stock positions in our publications )FEHF'VOET5PP.VDIPGB(PPE5IJOH and5IF&OWJBCMF%JMFNNBÂ&#x2021;$PODFOUSBUFE4UPDL)PME 4FMM PS)FEHF , respectively. 8 Our wealth forecasting model presents returns for up to 50 years. A portfolio invested 60% or more in equities will, in typical markets, support more than 50 years of spending at a 4% rate.

Multigenerational Wealth Management: Getting a Legacy Up

9


SIZING, SEGMENTING, AND ALLOCATING EXCESS CAPITAL

The only question with wealth is what do you do with it? John D. Rockefeller

5IFTJ[FPGUIFFYDFTTDBQJUBMNBZCFMBSHFPS TNBMM CVUJUTGBUFJTUIFTBNFÂ&#x2021;UIFTFBSFGVOETUIBU are very likely to go unspent and that will wind VQXJUIUIFJOWFTUPSTEFTDFOEBOUT DIBSJUZ PSUIF HPWFSONFOU*UTUIFJOWFTUPSTEFDJTJPOÂ&#x2021;PSJOEFDJTJPOÂ&#x2021;UIBUEFUFSNJOFTUIFJSĂŞOBMEFTUJOBUJPO"OE although almost all investors agree that giving more money than necessary to the government is undeTJSBCMF ZPVEPOUIBWFUPCFBTSJDIBT3PDLFGFMMFS to understand the difficulty of deciding how best to NPWFUIFGVOETUPCFOFĂŞDJBSJFT*OGBDU GPSTPNF  the most perplexing issue with regard to their wealth is how to leave it behind. Splitting Heirs: A Spectrum of Transfer Philosophies

%JÄ&#x201E;FSFOUJOWFTUPSTIBWFEJÄ&#x201E;FSFOUQIJMPTPQIJFTPO how best to share their wealth (Display 8 ). On one end of the spectrum are those who wish to leave as much as possible to their descendants, no matter IPXMBSHFBOJOIFSJUBODFUIBUNBZCF5IFTFJOWFTDisplay 8

Splitting heirs: A continuum of approaches to wealth transfer Maximize Wealth to Descendants

Maximum to Children

Core Capital

G1

Provide a Specific Benefit

Spread Among Generations

Targeted Sums Basic Needs to to Children Children/Maximum and Charity to Charity

G1

G1

G1 G2

G3

G2 G3 G4

G4

Charity

G2 Excess Capital

G2

Charity

Defining Specific Benefits: t Education t Entrepreneurial capital

t Supplement earned income t3FUJSFNFOUTFDVSJUZ

Source: AllianceBernstein

UPSTNVTUEFUFSNJOFIPXUPEJWJEFUIFJSXFBMUIÂ&#x2021; they may wish to leave it all directly to their children and grandchildren, or they may want to distribute all or a portion of the funds in a more controlled manner, such as in a trust that makes distributions once the beneficiaries reach a certain age or that continues in perpetuity to benefit future generations. At the other end of the spectrum are those who want to provide a specific benefit to their descendants, with the remainder set aside to fund, say, a favorite charity or other long-term philanthropic project. For example, they may wish to give their descendants just enough to pay for educational or medical needs, to foster entrepreneurial activities, to supplement income, or to provide retirement TFDVSJUZ*GTP UIFTFOJPSHFOFSBUJPODBORVBOUJGZUIF amount required to satisfy each goal and the time frame within which the beneficiaries will need the funds. In this way, funds can be segmented and allocated in a fashion most likely to meet those goals. We can use our Wealth Forecasting System to help a family address these issues. For example, say a husband and wife want to provide a fund that could CFVTFEJOZFBSTUPTVQQMFNFOUUIFJSDIJMESFOT retirement income. One approach is to determine how much the couple must set aside today, and at what allocation, to enable the children to spend at BDFSUBJOMFWFMÂ&#x2021;TBZ  FBDIQFSZFBS HSPXO with inflation over 30 years. According to our projections, based on an allocation of 80% stocks and CPOET UIBUBNPVOUJTNJMMJPO BTTVNJOH that the couple would like to meet that goal with BMFWFMPGDPOĂŞEFODF Display 9).*GUIFZBSF unwilling to reserve that much for this purpose, or EPOUSFRVJSFTVDIBIJHIMFWFMPGDFSUBJOUZPGNFFUJOHUIBUHPBM BMMPDBUJOHNJMMJPOXPVMEMFBWF UIFNXJUIBMFWFMPGDPOĂŞEFODFPGBDIJFWJOH their objective.

9 This assumes that the couple can make the funds set aside available to the children undiminished by transfer taxes. Deciding upon the level of confidence with which the couple

would like to meet an objective is important because itâ&#x20AC;&#x2122;s natural for families to prioritize certain objectives over others.

10

Bernstein Wealth Management Research


Defining, timing, and sizing a specific benefit Funds for Children

Funds for Grandchildren

Target: Provide retirement security for two children ($500,000 each, annually) beginning in 20 years*

Target: Provide for college and first home (at age 30) for each of six grandchildren*

$16.9

$ Mil.

$9.1 $4.6 $2.0 90% Confidence Level

50% Confidence Level

Amount to Reserve Today

90% Confidence Level

50% Confidence Level

Amount to Reserve Today

*After inflation This assumes the amount reserved for the children is invested 80% in stocks and 20% in bonds, that the amount reserved for the grandchildren is invested 100% in stocks, and that the grandchildren at the start of the analysis are ages 0, 2, 4, 6, 8, and 10. In both cases, we assume the couple can make the amount set aside available to beneficiaries undiminished by transfer taxes. Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: AllianceBernstein

5IFDPVQMFDBOUBLFUIFTBNFBQQSPBDIGPSPUIFS objectives. For example, they may also want to provide each of six grandchildren with a college FEVDBUJPOBOEUIFGVOETUPCVZBĂŞSTUIPNF-FUT TBZUIFZSFĂŞHVSJOHPO BZFBSGPSGPVSZFBST of college, grown with inflation, when each grandDIJMESFBDIFT BOE JOSFBMEPMMBSTGPSB nest egg at age 30. With these future costs and their timing in mind, we can calculate the amount of current wealth the family needs to reserve for this purpose, at different levels of confidence and different allocations. Finding a Mix That Fits: Multigenerational Allocations

After the senior generation identify what benefits they want to provide to which beneficiaries, they TIPVMEJODPSQPSBUFFBDICFOFĂŞDJBSZTSJTLQSPĂŞMF into the plan to improve their overall asset alloDBUJPO*OBMMPDBUJOHUIFBTTFUT UIFLFZGBDUPSTUP

consider include how vital the funds are and when they will be spent5IFZTIPVMEBMTPUBLFJOUPBDDPVOU other sources of capital available to the beneficiaSJFT TVDIBTFBSOFEJODPNFPSPVUTJEFXFBMUI5IFZ can then set the investment strategy for the bucket iSFTFSWFEuGPSFBDIQVSQPTF BOECVJMEUIFGBNJMZT asset allocation from the bottom up (Display 10). 'PSFYBNQMF UIFTFOJPSHFOFSBUJPOTSBJOZEBZGVOE  or emergency capital reserve, should be both liquid BOETBGF CFDBVTFJUNBZCFOFFEFEBUBOZUJNFÂ&#x2021; even in the near term. Accordingly, the equity component, if any, should be minimal.10 Business capital, which might be important to meet the liquidity needs of an illiquid asset in a cyclical downturn or to have available in case a new opportunity arises (which also could happen at any time), should MJLFXJTFCFDPOTFSWBUJWFMZBMMPDBUFEUPNBLFTVSFJUT there when needed. Display 10

Bottoms up: Start with core needs, then allocate across the generations Sample Range of Equity Recommendations 100

Excess for G4

75

Core C

Excess for G3

Excess for Charity

Excess for G2 Excess for G2 Equity %

Display 9

50

G1 Core Capital

25

Business Reserve Emergency Reserve

0 Today

In 10 Yrs. In 20 Yrs. In 30 Yrs. In 40 Yrs. In 50 Yrs. When Capital Will Be Spent

Source: AllianceBernstein

10 This is because in the short term, equities can be volatile and suffer significant losses, leaving an investor without adequate funds when he needs them most. Over the longer

term, however, the ability of equities to provide significant growth is remarkably consistent. For example, since 1926, there has been no 20-year period in which inflation has outpaced the S&P 500.

Multigenerational Wealth Management: Getting a Legacy Up

11


A CLOSER LOOK: Multigenerational Questionsâ&#x20AC;&#x201D;No Easy Answers 5IFTUBSUJOHQPJOUJOBOZUSBOTGFS plan is for the senior generation to EFĂŞOFXIPUIFZEMJLFUIFCFOFĂŞciaries of the funds to be, how much UIFZEMJLFUPHJWF BOEXIFOUIFZE MJLFUIFNUPSFDFJWFUIFBTTFUT*U seems as if this should be a relatively TUSBJHIUGPSXBSEFYFSDJTF)PXFWFS  wealth transfer is fraught with decisions that are both financially comQMFYBOEEFFQMZQFSTPOBMÂ&#x2021;BOEPGUFO the two are at odds. For instance, arguably the most powerful incentive UPUSBOTGFSXFBMUIEVSJOHPOFTMJGFtime is a desire to minimize transfer taxes. But transferring significant funds to younger generations at too young an age runs the risk of spoiling them and curbing the incentive for hard work that contributed to UIFGBNJMZTĂŞOBODJBMTVDDFTT#BMBODing tax-efficient wealth transfer with the psychological well-being of the younger generations is a delicate and EJÄ&#x2026;DVMUUBTL*UTBRVFTUJPOUIBUIBT generated many, often contradictory, QPJOUTPGWJFX)FSFBSFBGFXGSPN UIFSFDFOUÂ&#x2021;BOEOPUTPSFDFOUÂ&#x2021;QBTU

A very rich person should leave his kids enough to do anything but not enough to do nothing. Warren Buffett

To give away money is an easy matter and within any manâ&#x20AC;&#x2122;s power. But to decide to whom to give it and how much and when, for what purpose and how, is neither in every manâ&#x20AC;&#x2122;s power, nor is it an easy matter. Aristotle

If you think of life as like a big pie, you can try to hold the whole pie and kill yourself trying to keep it, or you can slice it up and give some to the people around you, and you still have plenty left for yourself. Jay Leno

Money is like manure; itâ&#x20AC;&#x2122;s not worth a thing unless itâ&#x20AC;&#x2122;s spread around encouraging young things to grow. Thornton Wilder, The Matchmaker

As I started getting rich, I started thinking, â&#x20AC;&#x153;What the hell am I going to do with all this money?â&#x20AC;? Ted Turner

Of course, moneyâ&#x20AC;Świll steadily work to unspiritualize and unchurch the people to whom it was bequeathed. Ralph Waldo Emerson

A philanthropist is a generous man whose relatives hate him. Anonymous

12

Bernstein Wealth Management Research


As discussed above, core capital is the amount SFRVJSFEUPTVQQPSUUIFTFOJPSHFOFSBUJPOTTQFOEJOHXJUIBWFSZIJHIEFHSFFPGDPOĂŞEFODF*UXJMM be tapped continuously over their remaining life spans and should be allocated in line with their tolerance for volatility; somewhere between 40% and 60% in equities is typical. Assuming the children are currently employed and might not need UPESBXGSPNUIFJSTIBSFPGUIFJSQBSFOUTFYDFTT capital until well into the future, equities should play a much greater role in the allocation of those funds. And this emphasis on equities is even more desirable for buckets earmarked for grandchildren or more remote descendants; here the time horizon is even longer, and capital allocated to those CFOFĂŞDJBSJFTTIPVMEIBWFUIFIJHIFTUSJTLQSPĂŞMF*O general, the more risk that can be taken, the higher the proportion of equities one should have in the allocation.11 5PVOEFSTUBOEUIFCFOFĂŞUTPGTVDIBNVMUJHFOerational approach to asset allocation, consider BGBNJMZXJUINJMMJPOJOMJRVJEBTTFUTXIPTF TFOJPSHFOFSBUJPOTQFOE QFSZFBS4BZUIF parents decide that, after reserving their core capital and setting aside an additional $3 million emergency reserve, they want to allocate their remaining assets to maximize the wealth that will eventually pass to their descendants. Currently, all their liquid BTTFUTBSFJOWFTUFEDPOTFSWBUJWFMZÂ&#x2021;JOHMPCBMMZ EJWFSTJĂŞFETUPDLTBOEJOCPOETÂ&#x2021;SFĂŤFDUJOHUIF TFOJPSHFOFSBUJPOTCFMJFGUIBU HJWFOUIFJSMFWFMPG XFBMUI JUJTOUQSVEFOUUPUBLFBOZNPSFSJTL #ZFYQMPSJOHUIFGBNJMZTHPBMT XFDBOTJ[FUIFWBSJous generational buckets and determine a â&#x20AC;&#x153;multigenerationalâ&#x20AC;? asset allocation optimized to achieve those HPBMT'PSFYBNQMF UIFTFOJPSHFOFSBUJPOBSFOUJOUFSested in making any money available to their children for at least another 10 years, so a more aggressive posUVSFGPSUIPTFGVOETNBLFTTFOTF5IFUJNFIPSJ[PO for the grandchildren and great-grandchildren is even

Display 11

Building the asset allocation generation by generation Current Allocation

Alternative Allocation

Senior Generation Focus

Multigenerational Focus

Capital Distribution and Allocations

G1 Core

G1 Excess

40/60

40/60

G1 Core

40/60

G2

75/25

G3

90/10

G4 100/0 Charity 80/20 Overall Asset Stocks Allocation 40%

Bonds

Bonds

60%

30% Stocks

70% Source: AllianceBernstein

longer, so a nearly all-equity strategy may be appropriate for this bucket. Building the allocation generation by generation results in an overall family asset BMMPDBUJPOPGHMPCBMTUPDLTCPOETJOTUFBEPG the original 40/60 mix (Display 11). 5IJTBOBMZTJTZJFMETUXPLFZJOTJHIUT 1. The senior generationâ&#x20AC;&#x2122;s lifestyle wonâ&#x20AC;&#x2122;t be at risk:

Since our asset allocation methodology starts by QSPUFDUJOHUIFTFOJPSHFOFSBUJPOTDPSFDBQJUBM OFFET UIFZDBOCFDPOĂŞEFOUUIBUUIFZMMOFWFS run out of money. By definition, their excess DBQJUBMJTNPOFZUIFZSFIJHIMZVOMJLFMZUP TQFOEÂ&#x2021;JOFÄ&#x201E;FDU UIFZSFKVTUIPMEJOHBOENBOBHing it for their descendants. As a result, they feel psychologically comfortable with the increased volatility that comes with a higher equity allocation for that excess capital. As Display 12, following page, illustrates, all the incremental volatility is being absorbed by the younger-generation family members, who are the beneficiaries of the excess funds and who have the time horizon and risk tolerance to handle it.12

11 We use equities as a proxy for â&#x20AC;&#x153;risky assetsâ&#x20AC;? in this illustration. In practice, investors with ample excess capital and long time horizons might well choose to include other assets

as well, such as private equity, real estate, and hedge funds, for a portion of the allocation.

12 Still, itâ&#x20AC;&#x2122;s important to note that, taken as a whole, the portfolio will be more volatile, and the senior generation must understand that.

Multigenerational Wealth Management: Getting a Legacy Up

13


Display 12

Display 13

The funds earmarked for the beneficiaries absorb all the incremental risk...

...and family wealth increases substantially

Range of Pretax Annual Returns (%)*

Projected Family Wealth*

Current G1 Core G2 G3 G4 Portfolio Capital Portfolio Charity Portfolio Portfolio 37.7 34.5 31.8 29.9

10% 50% 90%

19.6

6.2

6.2

(4.8)

(4.8)

7.5

7.8

8.4

8.0

Superior Markets $237 Mil. vs. $161 Mil. +47%

200 150

Typical Markets $116 Mil. vs. $95 Mil. +22%

100 50

(10.2)

(11.1)

(12.8)

(14.6)

*Over 50 years Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: AllianceBernstein

2. The familyâ&#x20AC;&#x2122;s total wealth is likely to increase substantially: By the time the senior generation reach

UIFJSMJGFFYQFDUBODJFT UIFGBNJMZTXFBMUIJTPWFS 20% greater, in typical markets, with no downside risk in poor markets (Display 13). And the upside, in strong capital markets environments, is FOPSNPVT.PSFPWFS SFHBSEMFTTPGUIFQPSUGPMJPT returns, the wealth will continue to exceed the TFOJPSHFOFSBUJPOTDPSFDBQJUBM )PXFWFS UIFSFJTPOFMJBCJMJUZPGUIJTTJHOJĂŞDBOU increase in total family wealth: the specter of an

13 Many states also impose a state death tax, which can add to the overall tax burden.

14

250

$ Mil.

Level of Confidence

19.6

Multigenerational Allocation (70/30) vs. Single Generation Allocation (40/60)

Bernstein Wealth Management Research

Core Capital

0 60

65

70 75 80 85 Age of Senior Generation

Poor Markets $54 Mil. vs. $53 Mil. +2%

90

*After spending, taxes, and inflation Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. â&#x20AC;&#x153;Superior marketsâ&#x20AC;? represent results at the 10% level of confidence in our Wealth Forecasting model; â&#x20AC;&#x153;typical markets,â&#x20AC;? the 50% level of confidence; and â&#x20AC;&#x153;poor markets,â&#x20AC;? the 90% level of confidence. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

FWFOMBSHFSFTUBUFUBYCJMM*OGBDU CBTFEPOBDVSSFOUUPQGFEFSBMFTUBUFUBYSBUFPG UIFGBNJMZJO the above example would see close to half of the $116 million they are likely to build lost to federal estate taxes.13 So once the family puts in place a multigenerational asset allocation to build family wealth, the next step is to reduce the amount of it SFNBJOJOHJOUIFTFOJPSHFOFSBUJPOTFTUBUFTBUUIFJS deaths by engaging in tax-efficient wealth transfer strategies during their lifetimes. â&#x2013;


OPTIMIZING WEALTH TRANSFER: AT THE RIGHT PACE, AT THE RIGHT TIME

Observe due measure, for right timing is in all things the most important factor. Hesiod

Itâ&#x20AC;&#x2122;s About Time

A Taxing Environment

Faced with the prospect of a significant amount of excess capital and a large estate tax, the essential question for most families is not whether to transfer assets to their descendants or charities, but when. 5IJTSFRVJSFTUIFTFOJPSHFOFSBUJPOUPFOHBHFJOB difficult balancing act: On the one hand, moving excess capital to beneficiaries as quickly as possible maximizes the likelihood of reducing estate taxes. And if the goal is to move more money to charity, the sooner the gift is made, the quicker the charitable impact and the greater the amount of tax-free growth on the gift.14 On the other hand, a more HSBEVBMUSBOTGFSNJHIUTBUJTGZUIFTFOJPSHFOFSBUJPOT desire to retain control and flexibility. Regardless of the pace the family decides on, the senior generation should identify the right strategies to achieve their intended wealth transfer trajectory without putting their core capital at risk (Display 14 ).

Of course, constructing and executing a sound XFBMUIUSBOTGFSQMBOJTFBTJFSTBJEUIBOEPOF5IJTJT MBSHFMZCFDBVTFEPOPSTDBOUFBTJMZHJWFBTNVDIUP their descendants as they want, whenever they want. 5IFSFBTPOJTTJNQMFÂ&#x2021;UIFHPWFSONFOUJNQPTFT three â&#x20AC;&#x153;transfer taxesâ&#x20AC;? on the transmission of wealth: r Estate tax:$VSSFOUMZMFWJFEBUBUPQSBUFPG  the federal estate tax applies upon death to the transfer of assets to someone other than a spouse PSDIBSJUZ(FOFSBMMZTQFBLJOH JUUBLFTBCJUFPVU of estates having assets in excess of the current $2 million estate tax applicable exclusion amount (the estate tax exclusion). r Gift tax: 5IFMJGFUJNFHJGUUBYBQQMJDBCMFFYDMVTJPO amount (the gift tax exclusion) from federal gift UBYJTMJNJUFEUPNJMMJPOQFSEPOPS*OHFOFSBM  gifts in excess of this exclusion to someone other than a spouse or a charity are subject to tax at SBUFTVQUP16 r Generation-skipping transfer (GST) tax:*OHFOFSBM  UIJTJTBUBYPOUSBOTGFSTUPPSGPSUIFCFOFĂŞU of grandchildren or more remote descendants. A donor can exempt up to $2 million from this tax, a valuable benefit for families with multigenerational intent.

Display 14

Planning the pace of wealth transfer, while ensuring that core needs are met Senior Generationâ&#x20AC;&#x2122;s Wealth No Planning

Wealth

5PHFUIFS UIFTFUISFFMFWJFTNBLFJUDIBMMFOHJOHGPS the senior generation to transfer substantial wealth without significant erosion. Aggressive Plan

Moderate Plan Core Capital

60

65

70

75

80

Age of Senior Generation Source: AllianceBernstein

85

90

A Surfeit of Strategies: The Alphabet Soup of Wealth Transfer Techniques

5IBOLGVMMZ UIFSFTOPTIPSUBHFPGUFDIOJRVFTUP aid families in their efforts to minimize these taxes (Display 15, page 17; see the Appendix for more detailed descriptions). But sorting through the alphabet soup of planning acronyms and weighing the pros and cons of each strategy can be overwhelming. Furthermore,

14 Furthermore, donors get an income tax deduction for lifetime charitable gifts. See pages 35â&#x20AC;&#x201C;39 for more details. 15 Under the estate plans put in place by most married couples, the estate tax is deferred until the death of the surviving spouse. 16 Special tax rules apply with respect to spouses who are not US citizens.

Multigenerational Wealth Management: Getting a Legacy Up

15


A CLOSER LOOK: Managing Multigenerational Wealthâ&#x20AC;&#x201D;From Art to Science

It is far better to foresee even without certainty than not to foresee at all. Henri PoincarĂŠ

Often, the financial modeling of wealth transfer strategies tends to be overly simplistic. For example, it may assume that the assets subject to transfer will produce a constant rate of return based on a historical average. Focusing on averBHFTJTOUBCBEXBZUPTUBSU CVUPGUFOUIFZEPOU tell us enough about future returns. After all, the average outcome almost never occurs: Most of the time we experience something better or XPSTFÂ&#x2021;TPNFUJNFTNVDICFUUFSPSNVDIXPSTF For example, assume that a client transfers $10 million of publicly traded stocks to a 10ZFBS [FSPFEPVU(3"5 For an explanation of how GRATs work, see pages 20 â&#x20AC;&#x201C;21. 5IFEJTQMBZ below shows three possible paths of returns that the assets could take over this 10-year period. *OFBDIDBTF UIFTUPDLTQSPEVDFBDPNQPVOE BOOVBMSFUVSOPG)PXFWFS UIFFYUFOUUP XIJDIUIF(3"5TVDDFFET PSGBJMT EJÄ&#x201E;FST greatly depending on which path of returns the stocks take along the way. As the remainder BNPVOUTJOUIFEJTQMBZTIPX SBOHJOHGSPN The modeling challenge: The path of returns matters Average Return

Return Path 2

Year 1

8.0%

25.9%

(3.5)%

Year 2

8.0

14.1

(1.1)

Year 3

8.0

11.6

2.6

Year 4

8.0

14.7

2.4

Year 5

8.0

9.8

6.9

Year 6

8.0

6.9

9.8

Year 7

8.0

2.4

14.7

Year 8

8.0

2.6

11.6

Year 9

8.0

(1.1)

14.1

Year 10

8.0

(3.5)

25.9

Compound Annual Return

8.0

8.0

8.0

$1.9

$5.7

Remainder ($ Mil.)

10-Year, Zeroed-Out GRAT Section 7520 Rate: 6.0%

$0.0 (Failure)

Contribution: $10 Million Annuity: $1,358,677

Source: AllianceBernstein

16

Return Path 1

Bernstein Wealth Management Research

million to zero), reliance on an assumed constant rate of return does not tell us with any precision what we can expect to achieve by implementing a particular wealth transfer technique, or how that technique compares to potential alternative techniques. 5PBEESFTTUIJTSFTFBSDIOFFE XFVTFPVS8FBMUI Forecasting System to evaluate estate planning strategies and their asset allocations to quantify the likelihood of achieving a particular transfer objective. Our analyses rely upon a proprietary Monte Carlo model that simulates 10,000 plausible future paths of returns for each asset class and inflation and produces a probability EJTUSJCVUJPOPGPVUDPNFT)PXFWFS UIFNPEFM does not randomly draw from a set of historical returns to produce estimates for the future. *OTUFBE PVSGPSFDBTUT  BSFCBTFEPOUIFCVJMEing blocks of asset returns, such as inflation, yields, yield spreads, stock earnings, and price multiples; (2) incorporate the linkages that exist among the returns of various asset classes; (3) take into account current market conditions at the beginning of an analysis; and (4) factor in a reasonable degree of randomness and unpredictBCJMJUZ*OBEEJUJPO PVSNPEFMQSPEVDFT  QMBVTJCMFQBUITGPSUIF4FDUJPOSBUF BOEGPS mortality-adjusted analyses, we incorporate life FYQFDUBODZ"TBOFYBNQMF UIFSFTBDIBODF UIBUBUMFBTUPOFNFNCFSPGBZFBSPMEDPVQMF XJMMTVSWJWFVOUJMBHF$POTFRVFOUMZ JOB mortality-adjusted analysis for that couple, at MFBTUPOFXJMMTVSWJWFVOUJMBHFJOIBMGPGUIF 10,000 scenarios we model; in the other half, both die at some earlier time. As a result, the most important planning quesUJPOTUIBUBXFBMUIZGBNJMZGBDFTÂ&#x2021;)PXNVDI can we tax-efficiently transfer to future generaUJPOT )PXRVJDLMZDBOXFEPJU BOE)PX MJLFMZBSFXFUPBDIJFWFPVSHPBMT Â&#x2021;DBOCF answered with greater precision. â&#x2013;


Display 15

Display 16

Evaluating the alphabet soup of transfer techniques...

...to optimize the estate plan Efficient Mix of Strategies

High

CRT Discount ed Asset

Gift

CLT

s

t Sale

men Install

After-Tax Wealth

fts Gi

Insu

ra

nce

FLP

Strategy 4 Strategy 2

Strategy 1 Strategy 5 High

Source: AllianceBernstein

JUTOPUTJNQMZBCPVUĂŞOEJOHUIFSJHIUone, but the right combination, as no single strategy is likely to NFFUBMMPGBXFBMUIZGBNJMZTPCKFDUJWFT Optimizing Multigenerational Wealth Transfer

)PXFWFS XFDBOIFMQNBOBHFUIFDPNQMFYJUZ By using quantitative modeling to analyze various estate planning strategies, we can better understand BTUSBUFHZTLFZWBSJBCMFT JODMVEJOHUIFpace at which it is likely to move funds to younger generations, its scalability (how much wealth it can move), its flexibility (its ability to move funds to multiple generations, or to be adjusted over time), and its overall efficiency (how likely it is to be successful in meeting a parUJDVMBSUSBOTGFSPCKFDUJWF 5IFSFTVMU XFCFMJFWF JTB real advance in the art of wealth transfer planning: a framework for identifying the best mix of strateHJFTÂ&#x2021;TPNFUIJOHBLJOUPBXFBMUIQMBOOJOHFÄ&#x2026;DJFOU GSPOUJFSÂ&#x2021;UBJMPSFEUPNFFUUIFTQFDJĂŞDHPBMTPGFBDI family (Display 16 ). (See also â&#x20AC;&#x153;A Closer Look: Managing Multigenerational Wealthâ&#x20AC;&#x201D;From Art to Science.â&#x20AC;?) Several observations have emerged from our research. Perhaps the most significant is that a donor with a large, liquid estate often can satisfy all of his wealth transfer goals using just a few straightforward

Strategy 3

Low

le

IDGT

GRAT RT

ab

x Ta

tion

QP

Found a

Control

Low

Source: AllianceBernstein

TUSBUFHJFTEJSFDUHJGUT *%(5T BOE(3"5T8JUI these techniques, a donor can move very substantial amounts of wealth to future generations at little, if any, tax cost. Moreover, the amounts committed to these strategies can be adjusted to satisfy a range of objectives relating to the size and speed of the transfer and the intended recipients. Some families, however, must use additional strategies. And they can easily do so. For example, a donor worried about early mortality can supplement these strategies through the purchase of life insurance. A family with substantial illiquid assets can use longer-term GRATs or other solutions more tailored to their specific needs. Families who want to ramp up the amount available to distant generations might employ such techniques as an installment sale to an IDGT or â&#x20AC;&#x153;intergenerationalâ&#x20AC;? GRATs (see pages 32â&#x20AC;&#x201C;35 for more details). And a donor with multigenerational philanthropic objectives can add a charitable vehicle, such as a private foundation, to solidify that piece of the family legacy. *OUIFOFYUUISFFTFDUJPOT XFJMMVTUSBUFUIFSFMBUJWF merits of each of these strategies and how they can best be combined, weighted, and prioritized. â&#x2013;

Multigenerational Wealth Management: Getting a Legacy Up

17


GIFTS, GRATs, AND IDGTs: THE BEDROCK OF MULTIGENERATIONAL WEALTH TRANSFER

Regardless of the size of the excess capital or the specifics of the familyâ&#x20AC;&#x2122;s goals, a combination of one or more of three basic estate planning toolsâ&#x20AC;&#x201D;gifts, GRATs, and IDGTsâ&#x20AC;&#x201D; can serve as the bedrock of a multigenerational wealth transfer strategy. Back to Basics

*UTFBTZUPTFFXIZBWFSZXFBMUIZGBNJMZNJHIU WJFXTJNQMFUBYGSFFHJWJOHTUSBUFHJFTÂ&#x2021;MJLF â&#x20AC;&#x153;annual exclusionâ&#x20AC;? gifts of $12,000 per donee and the lifetime gift tax exclusion of $1 million per donor18Â&#x2021;BTTPNFXIBUPGBOBGUFSUIPVHIU4VDI HJGUTKVTUEPOUseemBTJGUIFZSFMBSHFFOPVHIUP move the needle. But these basic strategies not only can move a surprising amount of wealth, they can also lay important groundwork for more substantial wealth transfer later on. Furthermore, starting these gifts early maximizes UIFJSMPOHUFSNCFOFĂŞU(JGUTBMMPXBEPOPSUP move all future income and appreciation on the

transferred property out of his estate. So for assets that grow in value, the earlier the funds are moved, the greater the transfer tax savings will be. Also, in the case of annual exclusion gifts, a gift not made is a wasted opportunity, since each gift constitutes a â&#x20AC;&#x153;use it or lose itâ&#x20AC;? proposition. 1MVT BTTVNJOHBEPOFFEPFTOUOFFEUIFGVOET for immediate consumption, the donor can make UIFTFHJGUTUP*%(5T XIJDIGVSUIFSFOIBODFTUIFJS CFOFĂŞU5IFBEWBOUBHFJTUIBUUIFGVOETJOUIFUSVTU BSFFYDMVEFEGSPNUIFEPOPSTFTUBUFGPSFTUBUFUBY purposes, but the income generated by the funds is JODMVEFEJOUIFEPOPSTJODPNFGPSJODPNFUBYQVSposes. Because the donor is legally responsible for

Display 17

The gifts that keep on giving: Gifts and IDGTs are a powerful combination Amount Available to Beneficiaries* Annual Exclusion Gifts

Lifetime Gift Tax Exclusion

Per Donee

Per $1 Mil. Gift

906

$ Thousands

800

628

600

Benefit of Tax-Free Growth in IDGT Growth

421

400

266

200 0 12 1

64 5

150

5.3

5

Gift

3.0

3 2.3

2 1

Benefit of Tax-Free Growth in IDGT

4.0

4 $ Mil.

1,000

1.0

1.3

1.7

Growth

0 10

15

20

Years

25

30

Gift 1

5

10

15

20

25

30

Years

*Median results, after inflation All accounts are invested in 100% globally diversified equities. Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: AllianceBernstein 17 The annual exclusion refers to a provision of the tax law under which the first $12,000 of property transferred in a given year to a donee or to certain types of trusts for his or

her benefit is excluded in the computation of the donorâ&#x20AC;&#x2122;s taxable gifts in that year. One such trust is a trust that gives a beneficiary whatâ&#x20AC;&#x2122;s called a â&#x20AC;&#x153;Crummeyâ&#x20AC;? power, which is a lapsing right of withdrawal over contributions to the trust. The annual exclusion is indexed for inflation and is therefore expected to increase over time. See IRC § 2503(b)(2). An annual exclusion gift made directly to a grandchild or to certain types of trusts for his or her benefit is also free from GST tax and doesnâ&#x20AC;&#x2122;t use up any of the donorâ&#x20AC;&#x2122;s GST exemption. 18 The use of the gift tax exclusion offsets on a dollar-for-dollar basis the amount of the estate tax exclusion available at the donorâ&#x20AC;&#x2122;s death. 19 There are a number of interests in or powers over a trust that a grantor may have that will cause it to be an IDGT. One common provision used by planners is for an IDGT to give the grantor the power, acting in a nonfiduciary capacity, to reacquire the trust principal by substituting other property of equivalent value. See IRC § 675(4). Bernstein does not provide tax, legal, or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions.

18

Bernstein Wealth Management Research


We can use our Wealth Forecasting System to quantify how much money a donor can move, and how quickly he can move it, just by making basic gifts to *%(5T'PSFYBNQMF CZNBLJOHBOOVBMFYDMVTJPO gifts to a trust for one beneficiary, a donor can transfer more than $400,000 in inflation-adjusted dollars PWFSZFBSTUJNFJOUZQJDBMNBSLFUT Display 17 ). Over 30 years that figure more than doubles, to over   BTUIFUSBOTGFSSFEBTTFUTHSPX*NQPSUBOUMZ  PGUIBU  BCPVU JTBUUSJCVUBCMFUP UIFTFOJPSHFOFSBUJPOTQBZNFOUPGUIFJODPNFUBYFT POUIFUSVTUTJODPNF Moreover, by using his $1 million gift tax excluTJPOUPNBLFBHJGUUPBTFQBSBUF*%(5 BEPOPSDBO USBOTGFSNJMMJPOJOZFBST BOEPWFSNJMMJPO in three decades. Note that over 30 years, about NPSFXFBMUIJTNPWFECZNBLJOHUIFHJGUUP BO*%(5UIBOCZNBLJOHJUUPBOPOHSBOUPSUSVTU And should the donor allocate $1 million of his (45FYFNQUJPOUPUIBU*%(5 UIFGVOETDPVMEBMTP benefit his grandchildren and more remote descendants without ever being subject to transfer tax.21 5IFXFBMUIUSBOTGFSQPUFOUJBMRVJDLMZJODSFBTFT for a married couple with multiple donees. As an example, consider a 60-year-old couple with 10 EPOFFTUXPDIJMESFO UIFDIJMESFOTUXPTQPVTFT  and six grandchildren. By making annual excluTJPOHJGUTUP*%(5TGPSUIFUXPDIJMESFOBOEUIFJS TQPVTFT BOOVBMFYDMVTJPOHJGUTUPTFQBSBUF*%(5T for the six grandchildren, and a $2 million gift to BOPUIFS TFQBSBUF(45FYFNQU*%(5 UIFiEZOBTUZ trustâ&#x20AC;?), the senior generation can transfer a total of almost $30 million in inflation-adjusted wealth in ZFBSTUJNFJOUZQJDBMNBSLFUT Display 18). (See the Appendix, page 45, for our wealth projections per donee, at varying levels of confidence, for assets held in an IDGT or taxable trust.)

Display 18

The wealth transfer potential of making tax-free gifts to IDGTs Amount Available to Beneficiaries* 30 25

10.9 20 $ Mil.

paying the income tax on the trust income, he can further reduce his estate while letting the trust assets grow tax-free for the younger generations.20

7.5

15

10.6 Dynasty Trust

5.0

10

8.0

3.2 5

0

IDGTs for Grandchildren

1.8

0.8 2.6 0.5

3.5 1.2

5

10

6.1 4.6 2.1

3.4

5.0

20

25

15

7.2

IDGTs for Children and Their Spouses

30

Years *Median results; after inflation All accounts are invested in 100% globally diversified equities. Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: AllianceBernstein

Targeted Giving with Gifts

/PX MFUTTBZUIFTFOJPSHFOFSBUJPOXBOUUPNPWF a targeted amount to their two children to suppleNFOUUIFJSSFUJSFNFOUJODPNF*OUZQJDBMNBSLFUT  BGUFSZFBSTUIFGVOETJOUIF*%(5TGPSUIFDIJMdren ($3.4 million), plus the funds in the dynasty trust ($6.1 million, from which distributions to UIFDIJMESFODPVMECFNBEF UPUBMNJMMJPOÂ&#x2021; enough to fund approximately $200,000 for each of the two children in annual spending over 30 years XJUIBMFWFMPGDPOĂŞEFODF On the other hand, the primary goal may be to provide for the grandchildren by helping them buy homes or pursue whatever career options they EFTJSF*GTP JOZFBSTUIFTFOJPSHFOFSBUJPODBO make just over $11 million available to them (or almost $2 million per grandchild), i.e., the total

20 Moreover, once funds are in the IDGT, they represent a kind of â&#x20AC;&#x153;war chestâ&#x20AC;? that provides the trustee with the flexibility to engage in a host of additional, more complex wealth

transfer strategies, including buying assets from the grantor without causing the grantor to realize any capital gain (because the IDGT is â&#x20AC;&#x153;ignoredâ&#x20AC;? for income tax purposes). This might include an installment sale by the grantor of liquid or illiquid assets to the IDGT (see â&#x20AC;&#x153;Giving to Grandchildren and Beyond,â&#x20AC;? on page 32, and â&#x20AC;&#x153;A Closer Look: Wealth Transfer with Illiquid Assets,â&#x20AC;? on page 36, for more on installment sales and illiquid assets). 21 In fact, a number of states have eliminated whatâ&#x20AC;&#x2122;s known as the â&#x20AC;&#x153;Rule Against Perpetuities,â&#x20AC;? a complicated legal rule that limits the length of time most trusts can continue. In these states, one can create a GST-exempt trust (commonly known as a â&#x20AC;&#x153;dynasty trustâ&#x20AC;?) that theoretically can last â&#x20AC;&#x153;forever.â&#x20AC;? As used in this research study, the term dynasty trust refers to any GST-exempt trust designed to last as long as the law allows.

Multigenerational Wealth Management: Getting a Legacy Up

19


Display 19

Can only tax-free gifts to IDGTs reduce a $20 million estate to core capital? Wealth of Senior Generation* $20 Mil. Initial Assets

Range Before Gifting 80

Superior Markets

60 $ Mil.

60 $ Mil.

Range After Gifting

80

40

40 Poor Markets

Typical Markets 20

20

Superior Markets

0

Typical Markets Core Capital

Poor Markets 0

Core Capital 60

65

70

75

80

85

90

Age of Senior Generation

60

65

70

75

80

85

90

Age of Senior Generation

*After spending, taxes, and inflation. Here and for similar cases analyzing the wealth of a familyâ&#x20AC;&#x2122;s senior generation, unless stated otherwise, the allocation of the senior generation is 60% stocks and 40% bonds; the allocation of the IDGTs for the children is 80% stocks and 20% bonds; and the allocation of all other trusts is 100% equities. Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. â&#x20AC;&#x153;Superior marketsâ&#x20AC;? represent results at the 10% level of confidence in our Wealth Forecasting model; â&#x20AC;&#x153;typical markets,â&#x20AC;? the 50% level of confidence; and â&#x20AC;&#x153;poor markets,â&#x20AC;? the 90% level of confidence. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

BNPVOUJOUIF*%(5TGPSUIFHSBOEDIJMESFOBOE UIFEZOBTUZUSVTU)PXFWFS JGUIFTFOJPSHFOFSBUJPO want to provide supplemental retirement income for the children as well as help the grandchildren buy a first home, or if they want to do more for FJUIFSHSPVQ UIFZMMOFFEUPUSBOTGFSFWFONPSF wealth in a tax-efficient manner. Giving Away the Estate

/PXMFUTMPPLBUUIFPUIFSTJEFPGUIFDPJOÂ&#x2021;UIF HSBOUPSTFTUBUF8IBUJGUIFTFOJPSHFOFSBUJPOTJNQMZ want to minimize estate taxes by reducing their FTUBUFTUPUIFJSDPSFDBQJUBM 5IFJSBCJMJUZUPBDDPNplish that goal depends on a number of factors, including their level of wealth, their spending, and the returns on their investments. )FSFXFTIPXUIFJNQBDUPOUIFTFOJPSHFOFSBUJPOT wealth before and after making tax-free gifts to *%(5T Display 19). We assume they start with $20 million and spend at a rate of 2% of their initial assets, HSPXOXJUIJOĂŤBUJPO5IFZNBLFBOOVBMFYDMVTJPOHJGUTUP*%(5TGPSUIFJSUXPDIJMESFO UIFJSUXP children-in-law, and their six grandchildren, and they transfer $2 million to a dynasty trust for their descendants. With $20 million, it takes the senior genera-

tion just over 30 years to reduce their wealth to their core capital, in typical markets (Display 19, right *G NBSLFUTIBQQFOUPCFQBSUJDVMBSMZXFBLÂ&#x2021;TBZ BUUIF UIQFSDFOUJMFPGFYQFDUFESFUVSOTÂ&#x2021;JUDPVMEUBLF less than 10 years.22 But if markets are strong, tax-free HJGUTUP*%(5TBMPOFTJNQMZXPOUEPUIFKPCÂ&#x2021;UIF TFOJPSHFOFSBUJPOTFTUBUFTXJMMDPOUJOVFUPHSPX unless they find additional ways to move the money. 5IJTJTUIFGVOEBNFOUBMMJNJUBUJPOPGCBTJDHJGUT 5IFJSBCJMJUZUPUSBOTGFSXFBMUIUBYGSFFJTDPOTUSBJOFE by the number of donors and donees. So if the senior HFOFSBUJPOTOFUXPSUIJT TBZ NJMMJPOBOEUIFZSF spending at a rate of about 2% of their initial assets, a strategy that uses only basic gifts will have even less of an impact (Display 20 5IFZMMOFFEBOBEEJUJPOBM tool or tools, regardless of the market environments they may encounter, to help them scale up both the amount and the pace of the wealth transfer. The Power of GRATs

One strategy that can add significant power to a NVMUJHFOFSBUJPOBMXFBMUIUSBOTGFSQMBOJTB(3"5  PSHSBOUPSSFUBJOFEBOOVJUZUSVTU"(3"5DBOQBTT BQPSUJPOPGBOBTTFUTBQQSFDJBUJPOPVUPGBEPOPST estate without any transfer tax.

22 For purposes of this analysis, if at any point in any trial (of the 10,000 we modeled) the senior generationâ&#x20AC;&#x2122;s estate is reduced to their core capital, they stop making annual

exclusion gifts and â&#x20AC;&#x153;turn offâ&#x20AC;? the grantor trust status of all IDGTs (so that those trusts thereafter pay their own income taxes).

20

Bernstein Wealth Management Research


Display 20

Can tax-free gifts to IDGTs reduce a $50 million estate? Not in the donorâ&#x20AC;&#x2122;s lifetime Wealth of Senior Generation* $50 Mil. Initial Assets Range Before Gifting

Range After Gifting

200

200 Superior Markets

150 $ Mil.

$ Mil.

150 100

Superior Markets 100

Typical Markets 50

Poor Markets

0

Core Capital 60

65

70

75

80

85

Typical Markets

50

Poor Markets Core Capital

0

90

60

65

Age of Senior Generation

70

75

80

85

90

Age of Senior Generation

*After spending, taxes, and inflation Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. â&#x20AC;&#x153;Superior marketsâ&#x20AC;? represent results at the 10% level of confidence in our Wealth Forecasting model; â&#x20AC;&#x153;typical markets,â&#x20AC;? the 50% level of confidence; and â&#x20AC;&#x153;poor markets,â&#x20AC;? the 90% level of confidence. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

)FSFTBTJNQMJĂŞFEFYBNQMFPGIPXJUXPSLT Display 21 5IFHSBOUPSUSBOTGFSTBTTFUTUPUIF(3"5Â&#x2021; MFUTTBZÂ&#x2021;CVUSFUBJOTUIFSJHIUUPSFDFJWFB ĂŞYFEBOOVJUZQBZNFOUGSPNUIF(3"5FBDIZFBS during its term, which can be as short as two years.23 5ZQJDBMMZ UIFQBZNFOUTBSFTFUTPUIBUUIFJSQSFTFOU WBMVFXIFOUIF(3"5JTGVOEFEÂ&#x2021;EJTDPVOUFECZ UIFTPDBMMFE4FDUJPOSBUFÂ&#x2021;FRVBMTUIFBNPVOU USBOTGFSSFEUPUIF(3"5 5IF4FDUJPOSBUFJT BOJOUFSFTUSBUFQVCMJTIFENPOUIMZCZUIF*34  *OPVSIZQPUIFUJDBMFYBNQMF JGUIFUSVTUXFSFFTUBCMJTIFEXIFOUIF4FDUJPOSBUFXBT UIF HSBOUPSXPVMECFFOUJUMFEUPBQBZNFOUPGBCPVU per year. Because the value of what the grantor retains equals the value of what he transfers, he makes no gift GPSHJGUUBYQVSQPTFTXIFOIFGVOETUIF(3"5 4VDI B(3"5JTTBJEUPCFi[FSPFEPVUu 5IF(3"5TVDceeds if the assets in the trust produce a total return in FYDFTTPGXIBUTOFFEFEUPNBLFUIFBOOVJUZQBZNFOUT to the grantor. For example, assume that the assets double in value (to $200) by the end of the first year BOEUIBUUIFSFJTOPHSPXUIUIFSFBGUFS5IFHSBOUPS gets back $108 in annuity payments, and the remainJOHJTSFNPWFEGSPNIJTFTUBUFGSFFPGHJGUUBY

Our research shows that for volatile assets (such as publicly traded stocks), a series of short-term, zeroedPVUiSPMMJOH(3"5TuÂ&#x2021;XIFSFJOUIFBOOVJUJFTGSPN POF(3"5GVOEUIFOFYUPOF BOETPPOÂ&#x2021;JNQSPWFT the likelihood and amount of wealth transferred WFSTVTBTJOHMF MPOHUFSN(3"5 See â&#x20AC;&#x153;A Closer Look: Rolling for Dollarsâ&#x20AC;&#x201D;How Rolling GRATs Work,â&#x20AC;? following page.) Display 21

Passing the buck: How a GRAT works Exploring the GRAT Option First Generation $100

GRAT

$54 Year 1

Personal Assets

$54 Year 2 $92 in Appreciation

Second Generation

Government

Grantor Trusts

Income Tax on GRAT Income

Source: AllianceBernstein

23 It might be legally permissible to establish a GRAT with a term of less than two years. However, for technical tax reasons, most planners do not feel comfortable with a shorter

term. Bernstein does not provide tax, legal, or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions.

Multigenerational Wealth Management: Getting a Legacy Up

21


A CLOSER LOOK: Rolling for Dollarsâ&#x20AC;&#x201D;How Rolling GRATs Work *OBSPMMJOH(3"5TUSBUFHZ UIFEPOPSTFUTVQ BTFSJFTPGTIPSUUFSN FH UXPZFBS (3"5T  using the annuity payments he receives each ZFBSUPGVOEBOFX(3"5)FDPOUJOVFTUIJT process for as long as he wishes. By contributJOHFBDIBOOVJUZUPBOFX(3"5 IFLFFQTUIF full amount committed to the strategy (say, $10 million) at work, thereby leveraging the wealth USBOTGFSQPUFOUJBMUPJUTGVMMFTU)FBMTPIBT several opportunities to move money through the strategy because the performance of each (3"5EFQFOETPOUIFSFUVSOPGJUTJOWFTUments over its two-year term. 5PVOEFSTUBOEXIZUIJTUZQFPGTUSBUFHZ tends to be a more powerful wealth transfer UFDIOJRVFUIBOBTJOHMFMPOHUFSN(3"5  DPOTJEFSUIFZFBSQFSJPECFUXFFO BOEÂ&#x2021;UIFXPSTUZFBSQFSJPEGPS64 TUPDLTTJODFUIF(SFBU%FQSFTTJPO"ZFBS [FSPFEPVU(3"5JOWFTUFEJOUIF41 would have had to outperform a hypothetiDBM4FDUJPOSBUFPGBCPVU CVUUIF BTTFUTJOUIF(3"5XPVMEIBWFEFMJWFSFEB compound annual return of only about 1.2% (display, lower right).*5IFCFOFĂŞDJBSJFTXPVME IBWFXPVOEVQXJUIOPUIJOH5IFTFSJTLTDBO CFNJOJNJ[FECZTUSVDUVSJOHUIF(3"5TXJUI shorter terms. Consider how a series of two-year rollJOH(3"5TXPVMEIBWFQMBZFEPVUJOUIF TBNFmQFSJPE5IFLFZUPUIFSPMMJOH (3"5TJTUIBUUIFZDBQUVSFUIFJOFWJUBCMF short-term volatility of the capital markets. Even though stocks compounded at only about 1.2% annually over the period, their SFUVSOTEJEOUNPWFJOBTUSBJHIUMJOF5IFUXP ZFBSTBOETBXTUSPOH41SFUVSOT  BTEJEBOE *Section 7520 of the Internal Revenue Code became applicable in 1989. For this example, we created a proxy for the Section 7520 rate in prior years based on the IRSâ&#x20AC;&#x2122;s current methodology. â&#x20AC; For illustrative purposes, this hypothetical example assumes a constant 5.8% 7520 rate.

22

Bernstein Wealth Management Research

And just a few strong years can be enough to spell success. As we saw, during that period a NJMMJPOZFBSUFSN(3"5XPVMEIBWF transferred no wealth. But two of the twoZFBSSPMMJOH(3"5TXPVMEIBWFCFFOTVDcessful, putting $3 million in the hands of the beneficiaries (display, far right). *OEFFE TJNQMZDBQUVSJOHWPMBUJMJUZJTMBSHFMZ XIBUESJWFTUIFTVDDFTTPGBSPMMJOH(3"5 strategy. As a result, it effectively enables a grantor to move not only future appreciation out of his estate, but also a portion of the underlying assets committed to the strategy. For example, suppose a grantor commits an asset worth $10 million to a series of two-year SPMMJOH(3"5T4VQQPTFGVSUIFSUIBUJOUIF ĂŞSTUZFBS UIFBTTFUTEFDMJOFJOWBMVFCZ UP NJMMJPO*OUIFOFYUZFBS UIFBTTFUTJODSFBTF JOWBMVF UPNJMMJPO5IFGPMMPXJOH ZFBS UIFBTTFUTBHBJOEFDMJOFJOWBMVFUP million, and so on, for a 10-year period. At the end of 10 years, the asset is still worth $10 milMJPOÂ&#x2021;UIFSFIBTCFFOOPHSPXUIBUBMM)PXFWFS UIF(3"5TXJMMIBWFNPWFENJMMJPO PVUPGUIFHSBOUPSTFTUBUFUSBOTGFSUBYGSFFâ&#x20AC; A long-term trust may not work in a poor market GRATs and Hurdle Rate: 10 Dismal Years Commitment to Rolling GRATs: $10 Mil. Initial Section 7520 Rate:

5.2%

10-Year S&P Compound Return:

1.2%

10-Year GRAT Remainder:

$0.0

24% 12%

14%

11%

19%

4%

(10)%

(9)%

(15)% (26)%

1965 1966 1967 1968 1969 1970 1971 1972 1973 1974


*OGBDU POFXBZUPFOIBODFBSPMMJOH(3"5 TUSBUFHZJTUISPVHIiBTTFUTQMJUUJOHu*OTUFBE PGTFUUJOHVQPOFUXPZFBS(3"5FBDIZFBS funded with a globally diversified portfolio PGTUPDLT BHSBOUPSDPVMETFUVQ TBZ GPVSÂ&#x2021; with each one housing a different asset class or style. For example, one series of rolling (3"5TXPVMECFGVOEFEXJUI64WBMVF TUPDLT BOPUIFSXJUI64HSPXUITUPDLT  another with developed international markets stocks, and another with emerging markets TUPDLT5IFMFTTEJWFSTJĂŞFEUIFBTTFUTJOFBDI TFSJFTPG(3"5T UIFHSFBUFSUIFFYQFDUFE volatility and the better the results. â&#x2013; Rolling GRATs: Even a few good years are enough Two-Year GRATs $10 Mil. Initial Value, 100% US Equities

Section 7520 Rate

S&P Compound Two-Year Return

GRAT Remainder (Mil.)

1965â&#x20AC;&#x201C;â&#x20AC;&#x2122;66

5.2%

0.6%

1966â&#x20AC;&#x201C;â&#x20AC;&#x2122;67

6.0

5.6

â&#x20AC;&#x201D;

1967â&#x20AC;&#x201C;â&#x20AC;&#x2122;68

6.0

17.4

1.9

1968â&#x20AC;&#x201C;â&#x20AC;&#x2122;69

6.8

0.8

â&#x20AC;&#x201D;

1969â&#x20AC;&#x201C;â&#x20AC;&#x2122;70

8.2

(2.5)

â&#x20AC;&#x201D;

1970â&#x20AC;&#x201C;â&#x20AC;&#x2122;71

8.8

9.0

â&#x20AC;&#x201D;â&#x20AC;Ą

1971â&#x20AC;&#x201C;â&#x20AC;&#x2122;72

7.0

16.6

1.1

1972â&#x20AC;&#x201C;â&#x20AC;&#x2122;73

7.2

0.8

â&#x20AC;&#x201D;

1973â&#x20AC;&#x201C;â&#x20AC;&#x2122;74

8.2

(20.8)

â&#x20AC;&#x201D;

$â&#x20AC;&#x201D;

Two-Year Rolling GRATs Cumulative Remainder: $3.0 Mil. â&#x20AC;ĄAlthough the GRATâ&#x20AC;&#x2122;s return was marginally above the Section 7520 rate, the annuity withdrawal after a year of underperformance versus the hurdle led to failure. Source: Roger G. Ibbotson and Rex A. Sinquefield, â&#x20AC;&#x153;Stocks, Bonds, Bills, and Inflation:Year-by-Year Historical Returns,â&#x20AC;? University of Chicago Press Journal of Business (January 1976); Standard & Poorâ&#x20AC;&#x2122;s; and AllianceBernstein

3PMMJOH(3"5TBSFBWFSZBUUSBDUJWFXFBMUIUSBOTGFS strategy for a number of reasons: r Scalability: A donor can commit an unlimited amount to the strategy if he wishes to ramp up the potential wealth transfer. r Reliability: 8IJMFBUXPZFBS(3"5JOWFTUFE in a diversified pool of publicly traded stocks succeeds only a little under 60% of the time, UIFSPMMJOH(3"5TUSBUFHZJTBMNPTUDFSUBJOUP succeed. According to our research, the odds are BCPVUUIBUBSPMMJOH(3"5TUSBUFHZXJMM NPWFBUMFBTUTPNFXFBMUIPVUPGUIFEPOPST estate in five years. r Flexibility:4JODFUIFUFSNPGFBDI(3"5DBOCF as little as two years, the donor retains the flexibility to stop the strategy at any time or to commit fewer or more assets to the strategy each time IFGVOETBOFX(3"5 r Limited financial downside:5IFEPOPSJTOPXPSTF PÄ&#x201E;ĂŞOBODJBMMZJGBOZJOEJWJEVBM(3"5GBJMT TJODF he receives back all assets contributed to that (3"5 r Legal acceptability:5IFMFHBMSFRVJSFNFOUTGPS DSFBUJOHB(3"5BSFEFTDSJCFEJOEFUBJMJOUIF *OUFSOBM3FWFOVF$PEFBOEBQQMJDBCMF5SFBTVSZ regulations. Display 22, following page, shows how much wealth JTUSBOTGFSSFEJOUIFNFEJBODBTFCZBSPMMJOH(3"5 strategy in which the assets remaining in any sucDFTTGVM(3"5QBTTUPBOEBSFIFMEJOBTFQBSBUF *%(55IFUPUBMXFBMUISFĂŤFDUFECZFBDICBSJOUIF display comprises the aggregate value of the assets SFDFJWFEGSPNUIF(3"5T UIFTVCTFRVFOUHSPXUI of those assets, and the portion of that growth UIBUJTBUUSJCVUBCMFUPUIFHSBOUPSTQBZNFOUPGUIF income taxes on the income from those assets. Assuming a $10 million commitment to the rolling (3"5TUSBUFHZ BOETVÄ&#x2026;DJFOUPUIFSBTTFUTUPQBZ the income taxes on the income of the assets in the (3"5TBOE*%(5T BEPOPSDPVMEFYQFDUUPNPWF $8 million of inflation-adjusted wealth out of his FTUBUFJOZFBSTUJNFJOUZQJDBMNBSLFUT"OEUIF longer the strategy continues, the more powerful JUCFDPNFT*OUXPEFDBEFT UIFTUSBUFHZQBTTFTPVU

Multigenerational Wealth Management: Getting a Legacy Up

23


Display 22

Display 23

Rolling GRATs add significantly to a planâ&#x20AC;&#x2122;s transfer potential...

...and the donor can size the commitment to meet a specific wealth transfer goal

Amount Available to Beneficiaries

Multiple of Contribution Transferred by GRATs to IDGT

$10 Mil. in Two-Year Rolling GRATs* $46

$ Mil.

40

$32

30

$22

20

$14

10 0

$3 10

5

Growth of Remainders

3

GRAT Remainders

$8 5

Two-Year Rolling GRATs* Benefit of Tax-Free Growth in IDGT

15

20

25

30

Years

4.6x

4 Multiple

50

50% Level of Confidence

3.2x 2.2x

2

1.4x

1

0.3x 0 0.0x 5

0.8x 0.2x 10

0.8x

0.5x 15

20

1.2x

25

1.7x 90% Level of Confidence

30

Years

*Median results; after inflation All accounts are invested in 100% globally diversified equities. Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: AllianceBernstein

*After inflation All accounts are invested in 100% globally diversified equities. Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: AllianceBernstein

$22 million in typical markets, and in three decades, BUPUBMPGNJMMJPOÂ&#x2021;NPSFUIBOGPVSUJNFTUIF amount committed to the strategy.

with the strategy over a 20-year period can still pass about 80% of the value of the funds he commits to the strategy. Specifically, to transfer $10 million in ZFBSTXJUIBMFWFMPGDPOĂŞEFODFSFRVJSFTB DPNNJUNFOUPGBQQSPYJNBUFMZNJMMJPO  million objective/0.8 multiple).

Display 23 illustrates how the amount transferred can be scaled up or down to meet various objectives. 5IFCMVFMJOFTIPXTUIFmultiple of any amount DPNNJUUFEUPUIFSPMMJOH(3"5TUSBUFHZUIBUB donor can expect to transfer, assuming typical markets, over various time periods. For example, if a donor wants to transfer a total of $10 million over a 20-year period, he should commit about $4.6 million of diversified equities to the strategy (the multiple 2.2 x $4.6 million commitment = $10 million transferred in 20 years). We also present the transfer multiple (the gray line) assuming the grantor wants to plan with a NVDIIJHIFSMFWFMPGDFSUBJOUZÂ&#x2021;UIFMFWFMPG DPOĂŞEFODF5IFEBUBJMMVTUSBUFUIBUFWFOJGNBSLFUT perform exceptionally poorly, a donor who sticks

Providing Defined Benefits with GRATs in the Mix

Display 24 shows the overall wealth transfer if the senior generation in our example (again, assuming BGBNJMZXJUIEPOFFTÂ&#x2021;UXPDIJMESFO UXPDIJMdren-in-law, and six grandchildren) combine basic HJGUTUP*%(5TXJUIBDPNNJUNFOUPGNJMMJPO UPSPMMJOH(3"5T24 With the addition of the rollJOH(3"5T UIFTFOJPSHFOFSBUJPOBSFCFUUFSBCMFUP NFFUBWBSJFUZPGXFBMUIUSBOTGFSHPBMT*OPVSQSFWJPVTFYBNQMF UIFZXFSFBCMFUPNBLFNJMMJPO available to the second generation in 20 years in typical markets using only annual exclusion gifts to *%(5TBOEUSBOTGFSSJOHNJMMJPOUPUIFEZOBTUZ USVTU5IBUXPVMECFFOPVHIUPQSPWJEFFBDIPG

24 Note that because of a complex tax rule (known as the estate tax inclusion period or â&#x20AC;&#x153;ETIPâ&#x20AC;? rule), GRATs are generally used to move funds only to the second generation.

Donors can nevertheless pass a limited amount from the GRATs to a GST-exempt dynasty trust, which gives the family the flexibility to use those funds for the benefit of either the second or the third generation. Most planners agree that the amount that the rolling GRATs can effectively add to the dynasty trust is limited to the difference between the GST exemption and the gift tax exclusionâ&#x20AC;&#x201D;or about $1 million per donor. In 2009, however, that amount is scheduled to increase to $2.5 million per donor. For more on the ETIP rule, see footnote 30 on page 32. Our analysis assumes that the first $2 million moved out of the senior generationâ&#x20AC;&#x2122;s estates through the rolling GRAT strategy is added to the dynasty trust (and that the senior generationâ&#x20AC;&#x2122;s remaining GST exemptions are allocated to that trust). All other funds moved out of the senior generationâ&#x20AC;&#x2122;s estates through the rolling GRAT strategy are added to the IDGTs for the children. Bernstein does not provide tax, legal, or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions.

24

Bernstein Wealth Management Research


Display 24

Combining gifts and GRATs to meet wealth transfer goals Amount Available to Beneficiaries* 80

10.9 60

IDGTs for Grandchildren

18.3 Dynasty Trust $ Mil.

7.5 40

13.8

5.0 20

0

1.8 6.0 0.8 4.5 1.6 6.6 5

10

3.2 7.9 12.9 15

IDGTs for

10.4

45.5 Children and Their Spouses

31.6

Estate Reduction with GRATs: How Low Can You Go?

21.0

20 Years

25

the need to make distributions to the children from the dynasty trust, thus allowing those funds to be used exclusively for the grandchildren. Previously, the grandchildren had only $11 million available to UIFNJOZFBSTUJNF QSPWJEJOHBOFTUFHHPGKVTU under $2 million for each of the six grandchildren. /PX UIFGVOETJOUIFEZOBTUZUSVTUBOEUIF*%(5T GPSUIFHSBOEDIJMESFOUPUBMNPSFUIBONJMMJPO JOUIFTBNFQFSJPE8JUIPVUUIF(3"5T UIFGBNily had to prioritize the gifts to either the second PSUIJSEHFOFSBUJPO8JUI(3"5TJOUIFNJY UIFZ have enough to accomplish both objectives, and then some.

30

*Median case, after inflation Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: AllianceBernstein

the two children with about $200,000 per year to supplement their retirement needs. But by adding BDPNNJUNFOUPGNJMMJPOUPBSPMMJOH(3"5 strategy, the donors can make $21 million available UPUIFDIJMESFOGSPNUIFJS*%(5TBMPOFwithout

For a couple whose goal is to minimize estate taxes by reducing their wealth to their core capital, SPMMJOH(3"5TDBOQSPWJEFBWFSZQPXFSGVMTPMVUJPO-FUTMPPLBHBJOBUUIFGBNJMZXJUINJMMJPO  spending at a rate of 2% of their initial assets. Remember, the combination of basic gifts and *%(5TBMMPXFEUIFTFOJPSHFOFSBUJPOUPSFEVDF their wealth to their core capital in about 30 years JOUZQJDBMNBSLFUDPOEJUJPOT"EEJOHSPMMJOH(3"5T enables them to accelerate the wealth transfer considerably and gives them more control over its TQFFE5IFZDBOTJNQMZTDBMFVQPSEPXOUIF BNPVOUUIFZDPNNJUUPUIF(3"5T EFQFOEJOHPO the desired rate of transfer.

Display 25

The bigger the commitment to GRATs, the larger the estate reduction...and the faster it comes Wealth of Senior Generation* $20 Mil. Initial Assets Poor CoreMarkets Capital Range After Gifting to IDGTs and $5 Mil. in GRATs

Core Capital Poor Markets

Range After Gifting to IDGTs and $10 Mil. in GRATs

Typical Markets

Typical Markets

Great Markets

Poor Markets Typical Markets Superior Markets

20 0

Core Capital 60

65

70

75

80

Age of Senior Generation

Great Markets

Poor Markets Typical Markets

40 $ Mil.

$ Mil.

40

85

90

20

Superior Markets

0

Core Capital 60

65

70

75

80

85

90

Age of Senior Generation

*After spending, taxes, and inflation For purposes of this analysis, in any trial (of the 10,000 we modeled) in which the sum of (a) the senior generationâ&#x20AC;&#x2122;s individually owned assets and (b) the amount in the GRATs falls below their core capital, the senior generation stop establishing new GRATs, stop making annual exclusion gifts, and â&#x20AC;&#x153;turn offâ&#x20AC;? the grantor trust status of any grantor trusts. Moreover, the senior generation also reduce the amount contributed to new GRATs in any trial to the extent necessary to maintain their core capital in a 60/40 stock/bond mix. Based on Bernstein estimates of the range of returns for the applicable capital markets over the periods analyzed. â&#x20AC;&#x153;Superior marketsâ&#x20AC;? represent results at the 10% level of confidence in our Wealth Forecasting model; â&#x20AC;&#x153;typical markets,â&#x20AC;? the 50% level of confidence;â&#x20AC;&#x153;poor markets,â&#x20AC;? the 90% level of confidence. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

Multigenerational Wealth Management: Getting a Legacy Up

25


Display 26

Scaling up the transfer: These bedrock strategies can reduce even very large estates Wealth of Senior Generation* $100 Mil. Initial Assets

Range with No Planning 400 Superior Markets

$ Mil.

300 200

Typical Markets 100 Poor Markets 0

Core Capital 60

65

70

75

80

85

90

Age of Senior Generation

Range After Gifting and $40 Mil. GRATs 200

20â&#x20AC;&#x201C;25 Yrs. to Core Capital

$ Mil.

Typical Markets 100 0

Core Capital 60

65

70

75

80

85

90

Age of Senior Generation

Range After Gifting and $60 Mil. GRATs

$ Mil.

200

15 Yrs. or Less to Core Capital

Typical Markets 100 0

Core Capital 60

65

70

75

80

85

90

Age of Senior Generation *After spending, taxes, and inflation Based on Bernstein estimates of the range of returns for the applicable capital markets over the periods analyzed. â&#x20AC;&#x153;Superior marketsâ&#x20AC;? represent results at the 10% level of confidence in our Wealth Forecasting model; â&#x20AC;&#x153;typical markets,â&#x20AC;? the 50% level of confidence; â&#x20AC;&#x153;poor markets,â&#x20AC;? the 90% level of confidence. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

For example, if their goal is to reduce their estates to UIFJSDPSFDBQJUBMBUBGBTUFSQBDF DPNNJUUJOHNJMMJPOUPSPMMJOH(3"5TXJMMEPJUJOBCPVUZFBST  in typical markets (Display 25, preceding page *GUIFZ XBOUUPEPJUFWFONPSFRVJDLMZÂ&#x2021;TBZ JOZFBSTÂ&#x2021; DPNNJUUJOHNJMMJPOUP(3"5TXJMMSFNPWFall of their excess capital, in typical markets. Once the senior generation reduce their estates to their core capital, they can stop making annual exclusion gifts, TUPQDSFBUJOHOFX(3"5T UVSOPÄ&#x201E;UIFHSBOUPSUSVTU TUBUVTPGUIF*%(5T BOEFTTFOUJBMMZCFEPOFXJUI lifetime wealth transfer, depending on market conditions or any change in their core needs. Scaling Up the Transfer

But what if the senior generation have a much greater amount of excess capital? Because of their TDBMBCJMJUZ (3"5TDBOFÄ&#x201E;FDUJWFMZSFEVDFFWFOBWFSZ MBSHFFTUBUFUPDPSFDBQJUBMÂ&#x2021;BOEBUBQBDFEFTJHOFE UPTVJUUIFTFOJPSHFOFSBUJPOTEFTJSFT'PSFYBNQMF  Display 26TIPXTIPXBSPMMJOH(3"5TUSBUFHZDBO be scaled up, almost without limit, to fully reduce an estate over different intervals of time. A 60-yearold couple starting with $100 million, with a 2% spending rate, would see their wealth grow to almost NJMMJPOXJUIOPQMBOOJOHJOUZQJDBMNBSLFUT But with a comprehensive gifting strategy and by DPNNJUUJOHNJMMJPOUP(3"5T UIFZDPVME bring their estates in line with their core capital JOUPZFBST"OEJGUIFZXFSFPMEFS PSJGGPS some other reason time were an issue, increasing the BNPVOUDPNNJUUFEUP(3"5TUPNJMMJPOXPVME SFEVDFUIFJSFTUBUFTFWFONPSFRVJDLMZÂ&#x2021;JOZFBST PSMFTT%FQFOEJOHPOUIFJSQSFGFSFODFT XFDBO pinpoint the optimal strategy, and they can alter it at essentially any point should their wishes or circumstances change. *OUIJTDBTF DPNNJUUJOHNJMMJPOXPVMESFRVJSF the senior generation to dip into their core capital UPGVOEUIF(3"5T"OEUIBUTQFSGFDUMZSFBTPOBCMF UPBQPJOU*UTJNQPSUBOUUPVOEFSTUBOEUIBUB donor need not limit the amount he commits to SPMMJOH(3"5TUPIJTFYDFTTDBQJUBM5IFSFBTPOJT

25 Recall, however, that core capital is calculated based on very conservative estimates of market performance (i.e., returns at the 95% level of confidence). As a result, after the

senior generation reduce their wealth to their core capital and stop the transfer of wealth, itâ&#x20AC;&#x2122;s highly likely that theyâ&#x20AC;&#x2122;ll again have excess capital in the future. Consequently, they should regularly reconsider their estate plan and the familyâ&#x20AC;&#x2122;s goals in the context of market performance. For more on this, see the section â&#x20AC;&#x153;Implementing, Monitoring, and Adjusting the Planâ&#x20AC;? on page 40.

26

Bernstein Wealth Management Research


UIBUUIFBOOVJUZQBZNFOUTGSPNB(3"5SFUVSOUP UIFEPOPSBMMPGUIFBTTFUTIFUSBOTGFSTUPUIF(3"5 JUTPOMZBQPSUJPOPGUIFBQQSFDJBUJPOEVSJOHUIF (3"5TUFSNUIBUJTSFNPWFEGSPNUIFEPOPST FTUBUF*GOFDFTTBSZ UIFEPOPSDBOVTFUIFBNPVOU SFUVSOFEUPIJNGSPNB(3"5UPNFFUIJTTQFOEJOH OFFET SPMMJOHPOMZUIFCBMBODFJOUPBOFX(3"5 5IFLFZJTTJNQMZUPFOTVSFUIBUUIFEPOPSTJOEJWJEual assets plusUIFBNPVOUJOSPMMJOH(3"5TOFWFS falls below his core capital figure.

Display 27

Effective planning can create outsize value $100 Mil. Initial Assets No Planning

Govâ&#x20AC;&#x2122;t $74

Children $95

Gifting and $60 Mil. in GRATs Dynasty Trust Govâ&#x20AC;&#x2122;t $20 $11 GST Grandchildren

GST

G3

G3

$6

G2

G2

Gov't

Gov't

Children $152

Cashing Out: Planningâ&#x20AC;&#x2122;s Benefits

So what does this achieve? Consider two scenarios, CFGPSFBOEBGUFSUIFJNQBDUPGFTUBUFUBY*OPOF UIF senior generation do no planning, and in the other, they engage in the strategies outlined above (Display 27 8JUIPVUQMBOOJOH UIFDPVQMFTNJMMJPO FTUBUF JOWFTUFE HSPXTUPBMNPTUNJMMJPO JOUZQJDBMNBSLFUT6QPOUIFTVSWJWPSTEFBUI UIF HPWFSONFOUHFUTBMJUUMFVOEFSIBMG PSNJMMJPO  MFBWJOHNJMMJPOGPSUIFDPVQMFTDIJMESFO0O the other side, by virtue of planning, the family has allocated its excess capital more aggressively, bringJOHUIFGBNJMZTQSFFTUBUFUBYXFBMUIUPNJMMJPOÂ&#x2021;BOJODSFBTFPGNJMMJPO5IFO CZNBLJOH CBTJDHJGUTUP*%(5TBOEDPNNJUUJOHNJMMJPOUP SPMMJOH(3"5T UIFDPVQMFNPWFOFBSMZBMMPGUIFJS excess capital out of their estates in the median case, MFBWJOHBWBTUMZSFEVDFEFTUBUFVQPOUIFTVSWJWPST EFBUI5IFSFTVMUJTFTUBUFUBYFTPGKVTUNJMMJPOÂ&#x2021;UIBUTBCPVUNJMMJPOJOUBYTBWJOHTÂ&#x2021;XJUI UIFSFNBJOEFS BCPVUNJMMJPO BDDSVJOHUPUIF ZPVOHFSHFOFSBUJPOT*OTVN QMBOOJOHIBTBEEFE about $83 million in value.26

(in $ Mil.) $169 Mil. $74 $95

(in $ Mil.) Total Wealth (Before Estate Tax) Estate Tax Wealth Transferred

$189 Mil. $11 $178

Total Advantage of Planning: $83 Mil.* *Mortality-adjusted. Assumes that the spouses die in same year, and that an inflationadjusted $2 million per person is exempt from estate taxes. In the case where there is estate planning, we further assume a $2 million initial gift to the GST-exempt trust and that the first $2 million in remainders from GRATs go to the GST-exempt trust. This reduces the remaining estate tax exclusion in this case to $2 million for the couple. Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

"TXFWFTIPXO JSSFTQFDUJWFPGBGBNJMZTXFBMUI or goals (whether they prefer transferring defined amounts to designated beneficiaries or simply want to reduce their estates quickly to their core capital), a transfer plan that combines basic gifts, *%(5T BOESPMMJOH(3"5TDBOCFBTTJNQMFBTJU is effective. â&#x2013;

26 This analysis assumes that, in the scenario in which the senior generation engage in no lifetime wealth transfer, their remaining assets after estate taxes pass to their children. In

the scenario in which they do engage in lifetime wealth transfer, their remaining assets after estate taxes are added to the trusts for their children.

Multigenerational Wealth Management: Getting a Legacy Up

27


THE MORTALITY GAP: WHAT IF DEATH INTERVENES?

Had we but world enough, and timeâ&#x20AC;Ś Andrew Marvell

Hedging Against the Risk of Early Mortality

For many families, life insurance plays a key role in providing income replacement to loved ones in the event of the premature death of a breadwinner. But for many wealthy families, income replacement is PGMJNJUFEJNQPSUBODFÂ&#x2021;JUTJOTVSJOHBHBJOTUUIFSJTL of a large estate tax at the death of the surviving TQPVTFUIBUTQBSBNPVOU-JGFJOTVSBODFDBOQMBZB role in hedging against that risk. For example, families with substantial illiquid holdings often rely on life insurance. A typical scenario involves the owner of a closely held business who wishes to transfer the business intact to his children. *OTVDIBDBTF UIFTFOJPSHFOFSBUJPONBZXJTIUP use a â&#x20AC;&#x153;second-to-dieâ&#x20AC;? life insurance policy to fund all or some portion of the estate tax attributable to the business to avoid its forced sale to cover the tax. Likewise, a family with a large liquid estate may use insurance to reduce the risk that the premature death of the senior generation will preclude them from transferring sufficient wealth during their MJGFUJNFT"GUFSBMM JGUIFTFOJPSHFOFSBUJPODBOU DPOUJOVFCBTJDHJGUT (3"5T BOE*%(5TGPSMPOH enough, they may fail to reduce their estates to their DPSFDBQJUBM5IBUTXIFSFMJGFJOTVSBODFNJHIULJDL in to replace some of the funds lost to estate taxes. )FSFTIPXTVDIBQMBONJHIUXPSL*OTUFBEPG NBLJOHBMMPGUIFJSBOOVBMFYDMVTJPOHJGUTUP*%(5T for the younger generations, the senior generation make some of those gifts to an irrevocable life insurance trust *-*5 5IFUSVTUFFPGUIF*-*5UIFOVTFT those funds to pay premiums on a second-to-die 28

Bernstein Wealth Management Research

MJGFJOTVSBODFQPMJDZPOUIFTFOJPSHFOFSBUJPOTMJWFT #FDBVTFUIFQPMJDZJTPXOFECZUIF*-*5 UIFEFBUI CFOFĂŞUJTOPUJODMVEBCMFJOUIFTFOJPSHFOFSBUJPOT FTUBUFT5IFUSVTUFFDBOCVZBQPMJDZXJUIBEFBUI benefit sufficient to cover the estimated estate tax UIBUXPVMECFEVFVQPOUIFJSFBSMZEFBUITÂ&#x2021;MFWJFE on both the remaining â&#x20AC;&#x153;excess capitalâ&#x20AC;? and their IJHIFSUIBOBOUJDJQBUFEDPSFDBQJUBM5PLFFQUIF cost of the insurance down, the policy might have a declining death benefit that expires at some predeUFSNJOFEQPJOUJOUIFGVUVSFÂ&#x2021;JEFBMMZ BUBSPVOEUIF UJNFXIFOUIFHJGUT (3"5T BOE*%(5TBSFMJLFMZ to have succeeded in removing all of the excess capital from their estates. Consider our previous example: a married couple aged 60 (with two children, two children-in-law, and TJYHSBOEDIJMESFOÂ&#x2021;BUPUBMPGEPOFFT XIPIBWF NJMMJPOBOETQFOENJMMJPOBOOVBMMZ5IFZIBWF embarked on a multigenerational wealth transfer plan UIBUJODMVEFTCBTJDHJGUT *%(5T BOENJMMJPOJO SPMMJOH(3"5T XIJDITIPVMEBMMPXUIFNUPSFEVDF Display 28

The mortality gap: Even aggressive strategies require time to work Projected Wealth of Senior Generation* $50 Mil. Initial Assets After Gifting and $30 Mil. in GRATs 60

$ Mil.

Most lifetime wealth transfer strategies take time to work, and this can present a significant problem: *GUIFTFOJPSHFOFSBUJPOTIPVMEEJFCFGPSFUIFZBSF able to move the desired funds to their beneficiaries, the plan will fail to accomplish many of their objectives, including minimizing estate taxes to the HSFBUFTUFYUFOUQPTTJCMF)PXDBOGBNJMJFTCSJEHF this mortality gap?

Capital Needs

Poor Markets Typical Markets

Mortality Gap

Range Before GreatGifting Markets

40 After Gifting and GRATs

20

CoreG1 Capital Capital Needs*

0 60

65

70

75

80

85

90

Age of Senior Generation *After spending, taxes, and inflation Based on Bernstein estimates of the range of returns for the applicable capital markets over the periods analyzed. â&#x20AC;&#x153;Superior marketsâ&#x20AC;? represent results at the 10% level of confidence in our Wealth Forecasting model; â&#x20AC;&#x153;typical markets,â&#x20AC;? the 50% level of confidence;â&#x20AC;&#x153;poor markets,â&#x20AC;? the 90% level of confidence. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein


Looking at our projections, the wealth transfer stratFHZUIFZWFDIPTFOXJMMFÄ&#x201E;FDUJWFMZiGSFF[FuUIFWBMVF PGUIFJSFTUBUFTBUBSPVOENJMMJPO XJUIUIFWBMVF declining progressively to their core capital. AssumJOHBOFTUBUFUBYSBUFPG UIFGBNJMZNJHIUDPOsider purchasing a policy of around $30 million to DPWFSUIFUBYJGUIFZTIPVMEEJFFBSMZ 5IJTBNPVOU JTNPSFUIBOUIFNJMMJPOPSTPOFFEFEtoday to address the potential estate tax burden, but it proWJEFTUIF*-*5XJUITPNFDVTIJPOUPBDDPVOUGPS the impact of asset growth and inflation over time.) Based on representative product and pricing in the life insurance industry, the family might be able to purchase such a second-to-die policy (with a death benefit of $30 million that would expire in 20 ZFBST GPSBOBOOVBMQSFNJVNPGBCPVU *G they use a portion of the $240,000 in annual exclusion gifts they can currently make (i.e., $12,000 x 10 beneficiaries x two parents) to pay this annual QSFNJVN UIFZTUJMMDVSSFOUMZIBWFBCPVU  FBDIZFBSUPHJWFUPUIF*%(5TGPSUIFTFDPOEBOE third generation to invest in the capital markets. Display 29 illustrates the pros and cons of buying the insurance policy based on different mortality dates. *GCPUITQPVTFTEJFFBSMZ EVSJOHUIFZFBSQFSJPE that the policy is in force), the insurance really pays PÄ&#x201E;Â&#x2021;SFTVMUJOHJOSPVHIMZNJMMJPONPSFJOJOĂŤBtion-adjusted wealth in the median case than if the TFOJPSHFOFSBUJPOIBEKVTUNBEFCBTJDHJGUTUP*%(5T  and allowing the senior generation to move their wealth effectively intact to their descendants. But the actuarial likelihood of such an early death JTPOMZBCPVU*GBUMFBTUPOFTQPVTFMJWFTQBTU ZFBSTÂ&#x2021;XIJDIIBTBQSPCBCJMJUZPGPDDVSSJOHÂ&#x2021; the surviving spouse will die after the insurance has CFFOEJTDPOUJOVFE*OUIBUDBTF UIFGBNJMZXPVME have been better off had the senior generation made

Display 29

The benefits and costs of insurance 30

Insurance Beneficial

Insurance Costly

20 $ Mil.

their estates to their core capital in less than 20 years no matter what markets they see (Display 28). Accordingly, the insurance policy should continue GPSPOMZZFBSTÂ&#x2021;BGUFSUIBUQPJOU UIFJSNPSUBMJUZJT unlikely to result in any avoidable estate tax hit.

10

Average Cost: $0.8 Million*

0

â&#x2030;¤ 20 Years: 8% > 20 Years: 92% Odds of Mortality

(10) 5

10

15

20 25 Years

30

35

40

*Mortality-adjusted; after inflation Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

BMMBOOVBMFYDMVTJPOHJGUTEJSFDUMZUPUIF*%(5T for their descendants (which would have invested the gifts in the capital markets) rather than making UIPTFHJGUTUPUIF*-*5 XIFSFUIFNPOFZXFOUUP UIFJOTVSBODFDPNQBOZ 5IFJOĂŤBUJPOBEKVTUFEDPTU  on average, is about $800,000. With these trade-offs in mind, the family and their advisors can decide whether having the peace of mind that the premaUVSFEFBUITPGUIFTFOJPSHFOFSBUJPOXPOUEFSBJM UIFGBNJMZTXFBMUIUSBOTGFSHPBMTJTXPSUIUIFQSJDF We should note that many investors take a different tack when it comes to incorporating insurance JOUPUIFJSXFBMUIUSBOTGFSQMBOT5IFZFTUBCMJTIBO *-*5UIBUCVZTBQPMJDZXJUIBEFBUICFOFĂŞUUIBUJT as large as possible, contributing all of their potenUJBMBOOVBMFYDMVTJPOHJGUTUPUIF*-*5UPQBZGPS the insurance and making none of them to their descendants. Often they eschew all other wealth USBOTGFSTUSBUFHJFTBOENBLFUIF*-*5UIFDFOUFSpiece of the plan. And unlike the insurance policy described above, which is designed to protect against a temporary risk, this one is designed to remain in force at the death of the surviving spouse, regardless of when that death occurs.

27 There is substantially no accumulation value or cash-surrender value in the policy that we are modeling. This illustration assumes a second-to-die policy with a secondary no-lapse

guarantee. The insureds were assumed to be 60-year-old residents of the state of Illinois, each in the highest medical underwriting category. Further information regarding this illustration is available upon request.

Multigenerational Wealth Management: Getting a Legacy Up

29


While this may prove to be wise, it is really more an investment decision than an estate planning EFDJTJPO*GUIFTVSWJWJOHTQPVTFEJFTFBSMJFSUIBO expected, the policy will deliver a high return on JOWFTUNFOU*G POUIFPUIFSIBOE BUMFBTUPOFPGUIF insureds lives a long life, the return on the policy becomes less appealing. Each policy has a â&#x20AC;&#x153;crossoverâ&#x20AC;? point at which the cost of the premiums builds to such an extent that the family would have been better off just investing in the markets. Quantitative analysis can help the family make a rational decision regarding whether to purchase insurance, and if so, how to optimally size the policy, based on a rigorous review of the data. Paying Gift Tax: A Better Strategy for Those in a Rush?

6QVOUJMOPX XFWFDPOTJEFSFEPOMZTUSBUFHJFT EFTJHOFEUPUSBOTGFSXFBMUIHJGUUBYGSFF5IJTCFHT the question: Would it ever make sense for a wealthy donor to purposely pay gift taxes? Although most donors are loath to pay gift tax, it might be a better PQUJPOGPSBEPOPSXJUIBTIPSUUJNFIPSJ[POÂ&#x2021;B WFSZFMEFSMZEPOPS GPSFYBNQMF5IFSFBTPOJT that the gift tax is computed on only the amount received by the donee, while the estate tax is due on the entire estate (including the assets in the estate used to pay the estate tax). For example, consider a donor with $6 million (Display 30 *GTIFHJWFTUIFTFBTTFUTUPIFSDIJMdren at her death, $3 million will be due the govFSONFOU 'PSTJNQMJDJUZTTBLF XFEJTSFHBSEUIF FTUBUFUBYFYDMVTJPOBOEBTTVNFBĂŤBUFTUBUF UBYSBUF )PXFWFS JGTIFHJWFTUIPTFBTTFUTUPIFS children during her lifetime, she can move $4 million to them because she owes gift tax only on that BNPVOUÂ&#x2021;JOUIJTDBTF BUBYPGNJMMJPOPOUIF HJGU5IBUNBLFTUIFFÄ&#x201E;FDUJWFHJGUUBYSBUFPOMZ JOTUFBEPG BTTVNJOHUIFEPOPSMJWFTGPSUISFF ZFBSTBGUFSUIFHJGU *GTIFEPFTOU UIFHJGUUBYJT includable in her estate for estate tax purposes, and the payment of the gift tax results in no overall tax savings.) While the analysis is sometimes a bit more complex, this example illustrates the potential benefit of paying gift taxes.

Display 30

Does it ever pay to pay gift tax? $6 Mil. Portfolio Lifetime Gift

Gift at Death

$2 Mil. in $4 Mil. to Gift Tax Children

$3 Mil. in $3 Mil. to Estate Tax Children

33%

50%

Effective Tax Rate Source: AllianceBernstein

Our Wealth Forecasting System can help a donor determine whether paying gift taxes is more attracUJWFUIBOBOBMUFSOBUJWFTUSBUFHZMJLFSPMMJOH(3"5T Consider an investor who wants to move $10 million out of his estate. We compared two strategies:  HJWJOHNJMMJPOEJSFDUMZUPIJTDIJMESFOBOE paying $3.1 million of gift tax, versus (2) commitUJOHUIFGVMMNJMMJPOUPSPMMJOH(3"5T28*OUIF latter strategy, we assume that the remaining propFSUZJOBOZTVDDFTTGVM(3"5QBTTFTUPBO*%(5GPS the children, and that the income taxes on both the (3"5TBOEUIF*%(5BSFQBJEGSPNUIF(3"5 annuities, with only the balance of each annuity QBZNFOUSPMMFEGPSXBSEJOUPBOFX(3"5 We analyzed the impact on the total wealth in UIFIBOETPGUIFOFYUHFOFSBUJPOÂ&#x2021;BGUFSJNQPTJOH FTUBUFUBYFTPOBMMBTTFUTSFNBJOJOHJOUIF(3"5T UIBUIBEOUCFFOUSBOTGFSSFE8FGPVOEUIBUJOUIF NFEJBODBTF UIFSPMMJOH(3"5TUSBUFHZCFBUTUIF outright gift and payment of gift tax in about six years. Considering that the grantor must live for at least three years after an outright gift for the payNFOUPGHJGUUBYFTUPSFEVDFUIFGBNJMZTPWFSBMMUBY burden, the period during which paying the gift UBYFTJTMJLFMZUPCFCFUUFSUIBOUIFSPMMJOH(3"5T narrows from six years to only three (see Display 31, left *OPUIFSXPSET QBZJOHHJGUUBYFTJTMJLFMZUPCF preferable in only a very limited number of cases.

28 We assume the gift is taxed at a 45% rate and that the donor has no remaining gift tax exclusion. 29 Indeed, even if the gifts are made with assets subject to a 30% â&#x20AC;&#x153;valuation discount,â&#x20AC;? the crossover point lengthens to only about nine or 10 years.

30

Bernstein Wealth Management Research


Display 31

Taxable gifts vs. GRATs: Whatâ&#x20AC;&#x2122;s the best approach? Odds a Taxable Gift Outperforms a Rolling GRAT Strategy

Advantage/Disadvantage of Taxable Gift vs. Rolling GRATs $6.9 Mil. Taxable Gift vs. $10 Mil. GRATs 5

100%

0

Taxable Gift Outperforms

50

Crossover

GRATs Outperform

$ Mil.

Probability

75

(5)

25

(10)

0

(15) 2

4

6

8

10

12

14

16

18

20

Years

Taxable Gift Advantageous

Poor Markets

Typical Markets

Rolling GRATs Advantageous

Superior Markets 2

4

6

8

10

12

14

16

18

20

Years

All accounts are invested in 100% globally diversified equities. Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: AllianceBernstein

.PSFPWFS UIFJOWFTUPSDBONBLFUIFSPMMJOH(3"5 strategy even more attractive by scaling up the amount committed. For example, even though he wants to move only $10 million out of his estate, he could still commit $20 million (or more) to (3"5T QSPWJEFEIFIBTUIPTFGVOET)FXPVME move more out of his estate sooner, and the strategy could be discontinued when $10 million had been USBOTGFSSFE5IJTXPVMESFEVDFUIFDSPTTPWFSQFSJPE versus the outright gift to just four years.

Furthermore, as seen in Display 31, right, the benFĂŞUTBSFTLFXFEJOGBWPSPGUIFSPMMJOH(3"5 TUSBUFHZ5IBUTCFDBVTFXJUIBOPVUSJHIUHJGU UIF most a grantor can save is the difference between UIFBOEFÄ&#x201E;FDUJWFUBYSBUFT BTJMMVTUSBUFE in Display 30 0OUIFPUIFSIBOE JGUIF(3"5T are really successful, the grantor can reduce the tax POUIFUSBOTGFSPGXFBMUIFWFOGVSUIFSÂ&#x2021;UPBTMJUUMF as nothing. So while paying some gift taxes might make sense for an elderly donor, for most, a rolling (3"5TUSBUFHZXJMMCFBNPSFBUUSBDUJWFTUSBUFHZâ&#x2013;

Multigenerational Wealth Management: Getting a Legacy Up

31


BUILDING ON BEDROCK FOR GENERATIONS TO COME: MULTIGENERATIONAL SOLUTIONS

A good man leaveth an inheritance to his childrenâ&#x20AC;&#x2122;s children. Proverbs 13:22

For all the attractiveness of the â&#x20AC;&#x153;bedrockâ&#x20AC;? mix of CBTJDHJGUT (3"5T BOE*%(5T JUJTOPUBQBOBDFB 5IJTJTQBSUJDVMBSMZUSVFGPSBWFSZXFBMUIZGBNJMZ with long-term multigenerational aspirations for UIFJSXFBMUI*OTVDIDBTFT UIFTFOJPSHFOFSBUJPO may wish to expand upon these bedrock strategies to accomplish, for example: r Large transfers to the third generation (and beyond): .PTUQMBOOFSTBHSFFUIBU(3"5TBSFPGMJNJUFEVTFJOBEEJOHGVOETUPB(45FYFNQUUSVTU designed to move wealth to grandchildren or more remote descendants. One solution often used to move more wealth to remote descendants JTBOJOTUBMMNFOUTBMFUPBO*%(5 r Illiquid transfers:5IFBTTFUTPGNBOZXFBMUIZGBNJlies consist largely of closely held businesses or DPNNFSDJBMSFBMFTUBUF5IFTFBTTFUTBSFJMMJRVJEBOE present unique challenges and opportunities when it comes to transferring them to descendants. r Multigenerational family philanthropy: For families who have significant charitable intent, a private foundation is often the vehicle of choice for passing on both the dollar value of their estates and their philanthropic values.

holy grail of estate planning, since those funds conceivably can escape transfer taxes forever. With this in mind, some practitioners believe that another wealth USBOTGFSUFDIOJRVFÂ&#x2021;LOPXOBTBOJOTUBMMNFOUTBMFUP BO*%(5Â&#x2021;TIPVMEBMXBZTCFBQBSUPGBXFBMUIZGBNJMZTFTUBUFQMBO*GUIJTTUSBUFHZTVDDFFET BOZXFBMUIJU NPWFTDBOCVJMEJOTJEFBGBNJMZTEZOBTUZUSVTU

*OUIJTTFDUJPO XFFYQMPSFUIFQSPTBOEDPOTPGUIF strategies typically used to address each of these issues.

"OJOTUBMMNFOUTBMFUPBO*%(5IBTTFWFSBMQPUFOUJBM BEWBOUBHFTPWFSB(3"5 1. Lower â&#x20AC;&#x153;hurdle rateâ&#x20AC;?: 5IFJOUFSFTUSBUFPOUIFOPUF (i.e., the AFR) is generally lower than the Section SBUFVTFEUPWBMVFB(3"5TBOOVJUZ5IJT means that the return that the assets must produce for the strategy to be successful is lower. 2. Deferral of principal repayment:5IFQSJODJQBMDBO be repaid as a balloon payment at the end of the note term. As a result, the annual interest payments to the grantor are smaller than the annuity QBZNFOUTGSPNB(3"5PGBOFRVJWBMFOUTJ[FBOE

Giving to Grandchildren and Beyond: Installment Sales to IDGTs

"TXFWFEJTDVTTFE HJWFOFOPVHIUJNF (3"5T can efficiently move an unlimited amount of liquid XFBMUIUPUIFTFDPOEHFOFSBUJPO)PXFWFS NPTU planners agree that their ability to transfer funds CFZPOEUIBUHFOFSBUJPO JOUPBMPOHUFSN(45 exempt trust that can benefit grandchildren or more remote descendants, is constrained.305SBOTGFSSJOH funds into such a dynasty trust is in many ways the

5PVOEFSTUBOEUIFSPMFUIBUBOJOTUBMMNFOUTBMFNBZ QMBZ MFUTĂŞSTUSFWJFXUIFNFDIBOJDTPGUIFTUSBUFHZ 5IFTFOJPSHFOFSBUJPOTFMMTBTTFUTUPBO*%(5JO exchange for a promissory note from the trustee. 5IFOPUFPCMJHBUFTUIFUSVTUUPSFQBZUIFHSBOUPSUIF full value of the assets sold, plus interest usually set at a statutory rate known as the Applicable Federal 3BUF "'3 5PFOTVSFUIBUUIFTUSBUFHZJTSFTQFDUFE for tax purposes, most planners recommend that the trust already hold assets equal to at least 10% of the total value of the assets.314PJGUIF*%(5EPFTOU already have sufficient assets, the grantor must make an initial â&#x20AC;&#x153;seedâ&#x20AC;? gift to support the purchase of the BTTFUT5IFTUSBUFHZTVDDFFETJGUIFBTTFUTTPMEUPUIF *%(5QSPEVDFBSFUVSOJOFYDFTTPGUIFJOUFSFTUSBUF payable under the note; any excess appreciation can TUBZJOUIF*%(5GPSUIFCFOFĂŞDJBSJFT

30 One major drawback of a GRAT is that it does not easily permit a grantor to leverage his GST exemption. The reason is that if a grantor dies during the term of a GRAT, all

or a portion of the value of the GRAT assets will be includable in his estate for estate tax purposes. As a result, the annuity term of the GRAT is what is known as an â&#x20AC;&#x153;estate tax inclusion periodâ&#x20AC;? (ETIP), and the law effectively prevents the allocation of a GST exemption to a trust while it is subject to an ETIP. As a practical matter, this means that a grantor cannot effectively allocate any GST exemption to a GRAT until the end of its annuity term. This limits the total amount that can pass from a GRAT to a trust meant to provide transfer-tax-free distributions to the grantorâ&#x20AC;&#x2122;s grandchildren or more remote descendants to the grantorâ&#x20AC;&#x2122;s unused GST exemption when the GRAT terminates. 31 Although the general rule under prevailing practice appears to be 10%, no tax or legal authority expressly sanctions 10% as a necessary or sufficient amount.

32

Bernstein Wealth Management Research


UFSN5IJTBMMPXTNPSFPGUIFBTTFUTUPSFNBJOJO UIF*%(5MPOHFSUPQSPEVDFBSFUVSOJOFYDFTTPG the interest due the grantor. 3. Greater flexibility:5IFUSVTUFFDPVMEDIPPTFUPQBZ off the note at any time or even renegotiate its terms. Also, the beneficiaries can receive distriCVUJPOTGSPNUIF*%(5CFGPSFUIFOPUFJTGVMMZ SFQBJEXJUIB(3"5 UIFZNVTUXBJUVOUJMUIF annuity term ends. 4. Reduced mortality risk:*GUIFHSBOUPSEJFTEVSJOH the term of the note, only the unpaid principal CBMBODFPGUIFOPUFJTJODMVEBCMFJOUIFHSBOUPST estate for estate tax purposes.32 By contrast, if a grantor dies during the term of a zeroed-out (3"5 JUJTMJLFMZUIBUUIFFOUJSFWBMVFPGUIF (3"5TBTTFUTXJMMCFJODMVEBCMFJOUIFHSBOUPST gross estate. 5. Greater leverage of GST exemption: Perhaps most JNQPSUBOU UIFHSBOUPSDBOBMMPDBUFIJT(45FYFNQUJPOUPUIFBNPVOUIFVTFTUPTFFEUIF*%(5 And because the installment sale is not considered BOBEEJUJPOUPUIFUSVTUGPS(45UBYQVSQPTFT BOZ FYDFTTBQQSFDJBUJPOUSBOTGFSSFEUPUIF*%(5BTB SFTVMUPGUIFTBMFXJMMBMTPCF(45FYFNQU )PXFWFS UIFJOTUBMMNFOUTBMFBMTPIBTBGFXTJHOJĂŞcant drawbacks. 1. Legal uncertainties:6OMJLFB(3"5 BOJOTUBMMNFOU sale is not explicitly sanctioned under the tax laws, and many planners therefore believe that it results in more legal and tax uncertainties than a (3"5 2. Economic downside risk: Because an installment sale requires a â&#x20AC;&#x153;seedâ&#x20AC;? gift, there is an important FDPOPNJDSJTL*GUIFTUSBUFHZGBJMT UIFHSBOUPS wastes some of his gift tax exclusion or returns to his estate property that he has otherwise already successfully transferred.

Because the grantor must use his gift tax exclusion (or pay gift UBY UPTFFEBO*%(5 BTFSJFTPGTIPSUUFSNiSPMMJOHuTBMFTUPBO*%(5JTJOGFBTJCMF33

3. â&#x20AC;&#x153;Rollingâ&#x20AC;? installment sales not feasible:

5IJTMBTUESBXCBDL UIFJNQSBDUJDBCJMJUZPGFTUBCMJTIJOHBTFSJFTPGTIPSUUFSN SPMMJOHTBMFTUPBO*%(5  particularly detracts from its effectiveness as a wealth USBOTGFSTUSBUFHZSFMBUJWFUPSPMMJOH(3"5T5PJMMVTtrate, we compared the following three strategies: r "OJOFZFBSTFSJFTPGUXPZFBSSPMMJOH(3"5T r "OJOFZFBSJOTUBMMNFOUTBMFUPBO*%(5XJUI marketable securities; and r "OJOFZFBSJOTUBMMNFOUTBMFUPBO*%(5XJUIB family limited partnership (FLP) interest, subject to a 30% discount.34 For the installment sales, we assume a $1 million iTFFEuHJGUBOEBOBEEJUJPOBMNJMMJPOTBMFUPUIF *%(5 GPSBUPUBMUSBOTGFSPGNJMMJPOUPUIF USVTU'PSUIFSPMMJOH(3"5T UPQSPWJEFBOBQQMFT to-apples comparison, we assume that the grantor DPNNJUTNJMMJPOUPUIF(3"5TBOENBLFTB TFQBSBUFHJGUPGNJMMJPOUPBO*%(5 UPXIJDIOP sale is made). We also assume that the assets remainJOHJOBOZTVDDFTTGVM(3"5BSFBEEFEUPUIFTFQBSBUF*%(5*OBMMDBTFT XFBTTVNFUIBUUIFBTTFUTBSF invested in a globally diversified equity portfolio. 5IFSFTVMUT Display 32, following page) show that SPMMJOH(3"5TZJFMETJHOJĂŞDBOUMZCFUUFSSFTVMUT UIBOUIFTBMFPGUIFFRVJUJFTUPBO*%(5*OUIF median case, the advantage amounts to $3 milMJPOÂ&#x2021;NJMMJPOWFSTVTNJMMJPO"OEUIF (3"5TUSBUFHZBMTPQSPWJEFTNJMMJPONPSFJO downside protection.

32 However, the law is unclear regarding the income tax consequences if the grantor dies while the note is outstanding. For example, it is possible that the IRS would take the

position that the grantorâ&#x20AC;&#x2122;s death results in capital gain to the grantor or his estate.

33 For example, assume that a grantor uses his $1 million gift tax exclusion to fund an IDGT with equities and sells an additional $9 million of equities to the IDGT in

exchange for a two-year note that pays interest only at the AFR (e.g., 4.11%) and a balloon payment of principal. Our analysis shows that the grantor will receive back at least a portion of his $1 million â&#x20AC;&#x153;seedâ&#x20AC;? gift more than one-third of the time. 34 We assume that the FLP holds globally diversified equities and that distributions from the FLP to the IDGT enable the IDGT to satisfy all payments on the note to the grantor. An installment sale of an interest in an FLP to an IDGT may involve a number of legal and tax risks and uncertainties that a GRAT funded with marketable securities would not have. Bernstein is not a tax or legal advisor. Any grantor considering the use of an FLP in connection with his or her estate planning should consult his or her tax or legal counsel. 35 Our analysis assumes that the promissory note provides for annual interest payments at an AFR of 4.72% and a balloon payment of principal at the end of the noteâ&#x20AC;&#x2122;s term. The initial Section 7520 rate for the GRATs is 5.8%.

Multigenerational Wealth Management: Getting a Legacy Up

33


Display 32

Display 33

Rolling GRATs vs. installment sale to an IDGT

Intergenerational GRATs: A better way?

Amount Available to Beneficiaries in Year 9 $ Mil.* IDGT: No Discount

IDGT: 30% Discount $22.3

Level of Confidence

10%

Senior Generation

Rolling GRATs $20.5

Children

$17.6

10%

8.6

50% 90%

50% 90%

7.7

4.7 0.0

2.0

2.4

*Median results; all accounts are invested in 100% globally diversified equities. Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: AllianceBernstein

Not surprisingly, the sale of the discounted FLP interFTUUPUIF*%(5DPNQBSFTNPSFGBWPSBCMZ"TTVNing that the interest is subject to a 30% discount, we FTUJNBUFUIBUUIF*%(5XPVMECFMFGUXJUIBCPVU million in the median case, almost $1 million more UIBOUIF(3"5TUSBUFHZ36 And on the downside, the result is only slightly worse than with the rolling (3"5TNJMMJPOWFSTVTNJMMJPO0GDPVSTF  the key difference is that all of the funds moved by the installment sale could be distributed to the grandchildren transfer-tax-free. By contrast, with the rolling (3"5TUSBUFHZ POMZUIFGVOETBUUSJCVUBCMFUPUIF PVUSJHIUHJGUUPUIF*%(5 BCPVUNJMMJPOPGUIF NJMMJPOJOUIFNFEJBODBTF BSF(45FYFNQU Another Idea: â&#x20AC;&#x153;Intergenerationalâ&#x20AC;? GRATs

But given some of the potential difficulties and VODFSUBJOUJFTPGUIFJOTUBMMNFOUTBMFUPUIF*%(5 B grantor should not lose sight of the fact that a family committed to tax-efficient wealth transfer may be able to move significant funds to grandchildren, and beyond, even without the strategy. Specifically, a cooperative family could consider implementing

GRAT

G1

GRAT

G2

IDGT for Grandchildren

G3

Source: AllianceBernstein

a series of what we might call â&#x20AC;&#x153;intergenerationalâ&#x20AC;? (3"5TBTBOBMUFSOBUJWF)FSFBHSBOUPS ( DPNNJUTBTTFUTUPBSPMMJOH(3"5TUSBUFHZ XIFSFJOUIF SFNBJOEFSPGBOZTVDDFTTGVM(3"5JTQBJEUPUIF HSBOUPSTDIJME ( 5IFDIJMEUIFODPNNJUTBOZ BNPVOUTIFSFDFJWFTUPIFSPXOSPMMJOH(3"5 TUSBUFHZ5IFSFNBJOEFSPGBOZTVDDFTTGVM(3"5 FTUBCMJTIFECZUIFDIJMEQBTTFTUPBO*%(5GPSUIF ĂŞSTUHSBOUPSTHSBOEDIJMESFO ( Display 33). We compared the amount of money that could be moved to grandchildren through either a 20-year JOTUBMMNFOUTBMFUPBO*%(5PSBZFBSJOUFSHFOFSBUJPOBM(3"5TUSBUFHZ5IFSFTVMUTTIPXUIBUUIF (3"5TUSBUFHZNPWFTTMJHIUMZNPSFXFBMUIUPUIF grandchildren in the median case (Display 34 5IF advantage is about $300,000 on an inflation-adjusted CBTJTNJMMJPOWFSTVTNJMMJPO"MTP JOUFSHFOFSBUJPOBM(3"5TQSPWJEFTVCTUBOUJBMMZNPSF QSPUFDUJPOPOUIFEPXOTJEF"UBMFWFMPGDPOĂŞEFODF UIF*%(5XPVMEIBWFGBJMFEBMUPHFUIFS USBOTGFSSJOHOPGVOET XIJMFUIF(3"5TUSBUFHZXPVME have passed almost $3.3 million to the grandchildren. .PSFPWFS XJUIUIFSPMMJOH(3"5TUSBUFHZ BTVCstantial portion of the initial $10 million committed to the strategy has also been moved out of the grantorâ&#x20AC;&#x2122;s estate and into the childâ&#x20AC;&#x2122;s estateÂ&#x2021;BCPVUNJMMJPOJO the median case. As a result, the grantor is left with

36 This assumes that the FLP is liquidated after the note is repaid. 37 For the installment sale, we assume a $1 million gift and an additional $9 million sale to the IDGT, for a total transfer of $10 million to the trust. For the intergenerational

GRAT strategy, we assume that the grantor commits $9 million to rolling GRATs and makes a separate gift of $1 million to an IDGT for the benefit of his grandchildren (to which no sale is made). Any assets remaining in any successful GRAT pass to the grantorâ&#x20AC;&#x2122;s child, who also commits them to a rolling GRAT strategy, and any assets remaining in any successful GRAT established by the child pass to a separate IDGT for the benefit of the grandchildren. In both cases, we assume that the assets are invested in a globally diversified equity portfolio.

34

Bernstein Wealth Management Research


Multigenerational Philanthropy: Passing On Valueâ&#x20AC;&#x201D;and Values

Display 34

Gauging long-term transfer potential: intergenerational GRATs vs. installment sale to IDGT

5IFSFBSFNBOZXBZTUPHJWFQIJMBOUISPQJDBMMZ %POPSTDBOHJWFEJSFDUMZUPDIBSJUZFJUIFSEVSJOH their lifetimes or at their deaths, or they can give through special tax-advantaged vehicles, including certain trusts. Since a charitable gift can be made free of gift or estate tax, determining how to proceed hinges more on the emotional benefits that different forms of giving might offer and the potential JODPNFUBYTBWJOHT5IFTFTBWJOHTNBZJODMVEFBMBSHF up-front income tax deduction, a tax-advantaged environment in which to grow the gifted assets, an efficient vehicle for portfolio diversification, or a mechanism for leveraging multigenerational giving.

Wealth Available for Each Generation* $ Mil. 10 Years

20 Years

30 Years 11.7

4.9 Child 5.6 IDGTs for 2.8 Grandchildren GRAT

4.9 IDGT

9.7

19.2

10.5 27.9

10.8

10.5

GRAT

IDGT

19.2 GRAT

IDGT

*Median results, after inflation; all accounts are invested in 100% globally diversified equities. Long-term Applicable Federal Rate used in installment sale to IDGT cases was 5.09%. The initial 7520 rate was 5.8% in this analysis. Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: AllianceBernstein

%FUFSNJOJOHXIJDITUSBUFHZJTSJHIUGPSBHJWFO donor depends on his unique circumstances and objectives. (For a comparison of the salient characteristics of a broad sample of charitable giving strategies, see Display 35.) For example, a donor with the dual goals of establishing a regular income stream for himself and leaving a charitable legacy may find a charitable remainder trust appealing, particularly if he owns large amounts of low-basis stock, which can be diversified inside the trust with the capital gains taxes deferred. On the other hand, GPSBEPOPSXIPTJOUFSFTUFEJOUSBOTGFSSJOHXFBMUI UPEFTDFOEBOUTUSBOTGFSUBYGSFFÂ&#x2021;BOEXIPEMJLFUP CFHJOHJGUTUPDIBSJUZOPXÂ&#x2021;BDIBSJUBCMFMFBEUSVTU may be appropriate.

only $4.8 million from the original $10 million. By DPOUSBTU UIFJOTUBMMNFOUTBMFUPUIF*%(5MFBWFTUIF HSBOUPSXJUIBCPVUNJMMJPO5IVT UIFJOUFSHFOFSBUJPOBM(3"5TUSBUFHZBMTPEPFTBNVDICFUUFSKPC of helping the grantor reduce his estate. 5IFQPJOUJT EVFUPUIFJSTDBMBCJMJUZBOEĂŤFYJCJMJUZ  SPMMJOH(3"5TNBZIBWFBQQMJDBUJPOTJOBSFBTXIFSF they have traditionally been excluded or overlooked, including moving wealth to grandchildren. Display 35

Structured-giving alternatives to direct charitable gifts: a representative sample When Charity Receives Gift

Tax-Free Environment

Personal Income Tax Deduction

Other Key Benefits

Private Foundation

Beginning now, over time

Yes*

Generally, based on fair market value of gift

Control and multigenerational legacy

Public Charities (Donor-Advised Funds, Supporting Organizations)

Beginning now, over time

Yes

Generally, based on fair market value of gift

Donor has no administrative responsibilities

Charitable Remainder Trust (CRT)

At expiration of CRT

Yes, but distributions may result in income to recipient

Limited to present value of remainder interest when CRT is established

Income stream to donor

Charitable Lead Trust (CLT)â&#x20AC;

Beginning now, over a fixed period of years

Noâ&#x20AC;Ą

No

Potential tax-free transfer to children

Vehicle

*There is an excise tax of 1% â&#x20AC;&#x201C;2% on net investment income. â&#x20AC; Assumes a non-grantor CLT â&#x20AC;ĄA CLT generally receives a tax deduction each year equal to the lesser of the contribution to charity or the trustâ&#x20AC;&#x2122;s income.

Multigenerational Wealth Management: Getting a Legacy Up

35


A CLOSER LOOK: Wealth Transfer with Illiquid Assets So far we have been assuming that the senior HFOFSBUJPOTXFBMUIDPOTJTUTMBSHFMZPGMJRVJE assets. But many families hold illiquid assets, such as a closely held business, commercial real estate, or an interest in a private partnerTIJQ5IFTFQSFTFOUEJÄ&#x201E;FSFOUDIBMMFOHFTÂ&#x2021;BOE PQQPSUVOJUJFTÂ&#x2021;XIFOUSBOTGFSSJOHXFBMUI 5IFJTTVFJTUIBUUIFTFBTTFUTBSF XFMM JMMJRVJE 5IFZBSFOPUNBSLFUBCMFTFDVSJUJFTQSJDFE daily in public exchanges, but holdings that are priced only as specific needs dictate, with the help of a valuation expert who analyzes market comparables or discounted cash flows. Nevertheless, this constraint enables owners of illiquid assets to take advantage of several iMFWFSBHJOHuPQQPSUVOJUJFT5IFZDBOCFOefit from valuation discounts on the assets (imposed due to lack of marketability or a minority interest status), strong or improving cash flows from the assets, and event-driven JODSFBTFTJOUIFJSWBMVF5PDBQJUBMJ[FPOUIFTF leveraging opportunities, one simply needs to modify the wealth transfer strategies we have already discussed. For example, basic gifts can easily be made with illiquid assets based on a recent valuation. #VUXJUIBWBMVBUJPOEJTDPVOU JUTQPTTJCMFUP leverage up the amount of property transferred. Consider a minority shareholder interest in a QSJWBUFDPNQBOZ*GJUJTTVCKFDUUPBWBMVBtion discount because of a lack of marketability and its minority status, the intrinsic value that can be sheltered from gift tax by the gift excluTJPOJODSFBTFTGSPNNJMMJPOUP   5IBUFOBCMFTUIFTFOJPSHFOFSBUJPOUPHFUNPSF of the asset to the next generation faster.

Are GRATs As Great for Illiquid Wealth?

8JUITPNFNPEJĂŞDBUJPO (3"5TDBOBMTP work well with illiquid interests. Specifically, donors may be able to take advantage of opportunities to transfer interests in illiquid BTTFUTCZFYUFOEJOHUIF(3"5UFSNJO anticipation of event-driven value increases. Consider the increase in value for a minority shareholder when a business is sold in its entirety for cash, thereby entitling the minority shareholder to a proportionate share of the full â&#x20AC;&#x153;enterpriseâ&#x20AC;? value of the business. For example, QSF*10TUPDLPSTUPDLJOBQSJWBUFDPNQBOZ that is expected to be sold for its enterprise value in a relatively short time might be DPOUSJCVUFEUPB(3"5XJUIBTMJHIUMZMPOHFS UFSN*OTVDIDBTFT QMBOOJOHJNQMFNFOUFE in anticipation of the event can facilitate the transfer of all or a portion of that value increase to younger-generation beneficiaries without, or with reduced, transfer tax costs. *OUIFDBTFPGBOBTTFUMJLFSFBMFTUBUFPSBGBNJMZ CVTJOFTT UIFSFTBOPQQPSUVOJUZUPMFWFSBHFUIF BTTFUTDBTIĂŤPXT4USPOHPSJNQSPWJOHDBTIĂŤPXT can facilitate transfers with financing internally generated by the business or from the asset itself. 5PBMMPXJODSFBTJOHDBTIĂŤPXUPGVOEBOOVJUZ payments more effectively, one could extend the UFSNPGUIF(3"5BOEUBLFBEWBOUBHFPGUIF ability to step up the annuity payment by 20% FBDIZFBS"ZFBS(3"5TUSVDUVSFEJOUIJT GBTIJPOBOEGVOEFEXJUIBNJMMJPOJMMJRVJE asset (after a 30% discount) would require an initial annuity payment of only approximately   DPNQBSFEXJUIBOJOJUJBM  BOOVJUZQBZNFOUJGUIF(3"5UFSNXFSFĂŞWF years and no discount applied.*

* This assumes a 7520 rate of 5.0%. Of course, the longer term of the GRAT increases the risk that the grantor might die during the GRAT term, resulting in the inclusion of

all or a portion of the GRAT assets in the grantorâ&#x20AC;&#x2122;s estate for estate tax purposes.

â&#x20AC; Some planners even structure the note so that the interest is capitalized each year, and the trust makes no payouts until the note term expires. Bernstein does not provide tax,

legal, or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions.

36

Bernstein Wealth Management Research


A Non-GRAT Alternative: Installment Sales to IDGTs

)PXFWFS POFPGUIFQSPCMFNTPGVTJOH(3"5T to transfer an illiquid asset is that every year the (3"5NVTUEJTUSJCVUFQSPQFSUZCBDLUPUIF HSBOUPS&WFOJGJUJTBMPOHUFSN(3"5BOEUIF trust is created with a 20% increasing annuity (the combination of which will make the early annuities very small), eventually the annuity distributions will probably be large enough that they will have to be paid out with something other than DBTIPSMJRVJEBTTFUT*OUIBUFWFOU FJUIFSGSBDtional interests in the illiquid asset will need to be distributed (requiring more frequent valuations) or the illiquid asset will need to be sold. "OJOTUBMMNFOUTBMFUPBO*%(5NBZQSPWJEF greater flexibility. For example, the note can be drawn up so that the trust is required to pay interest only during the life of the note, then make a balloon payment of the principal of the OPUFBUUIFFOEPGUIFOPUFTUFSNâ&#x20AC; For an asset that generates a low amount of income, paying out interest only can be a more attractive feature UIBOUIFQBZPVUTUSFBNTBTTPDJBUFEXJUI(3"5T *OBEEJUJPO UIFOPUFDBOCFXSJUUFOTPUIBUJU can be paid down early with no penalty or be refinanced if interest rates have declined. Ready to Roll: Leveraging Liquid Wealth to Transfer Illiquid Assets

A particularly effective strategy can be to use liquid wealth to transfer illiquid holdings. With liquid wealth to draw on, a grantor could use BSPMMJOH(3"5TUSBUFHZUPUSBOTGFSNBSLFUBCMF TFDVSJUJFTUPBO*%(55IF*%(5DBOUBLFUIF liquid assets, and without triggering capital gains taxes, use them to purchase illiquid assets from the grantor, taking advantage of any valuation EJTDPVOUT5IFOUIFHSBOUPSDBOTUBSUUIFQSPDFTT BMMPWFSBHBJO GVOEJOHGVSUIFSSPMMJOH(3"5T XJUIUIFMJRVJEBTTFUTSFDFJWFE5IJTTUSBUFHZDBO provide an elegant, flexible, and effective means of transferring illiquid assets. â&#x2013;

Other donors may choose to make a gift for the sole benefit of charity. For them, a private foundation or a donor-advised fund may make the most TFOTF5IFTFWFIJDMFTBSFGSFF PSWJSUVBMMZGSFF PG income taxes and provide the donor with an immediate income tax deduction up to the full value of the gift, even though the assets can be distributed to charity over a very long period of time.38 A private foundation also offers nonfinancial benefits to a donor who wishes to establish a multigenerational charitable legacy. First, a private foundation can theoretically exist in perpetuity. Accordingly, it allows a donor to create a platform for his family to make charitable gifts for generaUJPOT5IFGPVOEBUJPONBZSFNJOEZPVOHFSHFOFSBtion family members of their good fortune, heritage, BOESFTQPOTJCJMJUZUPTIBSFXJUIPUIFST*UBMTPDBO provide the senior generation with a way to expose their descendants to a variety of important causes that the senior generation cherish, and provide those descendants with experience of the challenges of running an organization. (For more on foundations, see our earlier publication Looking Beyond Perpetuity: Customizing a Private Foundation.) Families interested in establishing a private foundation must consider how to integrate it into their overall multigenerational wealth plan. One important question is whether the senior generation should fund the foundation during their lifetimes or delay funding until their deaths. And if they choose to fund it while alive, how much can they give to the foundation without derailing their plans to NPWFNPOFZUPUIFJSDIJMESFOPSHSBOEDIJMESFO *O addition to the nonfinancial benefits a foundation can provide, donors should weigh the following: r Value of tax-deferred growth: A foundation funded during life increases the total wealth to charity CFDBVTFUIFBTTFUTHSPXWJSUVBMMZUBYGSFF5IFTJ[F of the advantage depends on factors such as the MFOHUIPGUJNFVOUJMUIFEPOPSTEFBUIBOEUIFUBY efficiency, return, and cost basis of the assets when they are contributed to the foundation. 38 Various limitations apply to the size of the personal income tax deduction a donor

can use to offset income for each of these strategies. Bernstein does not provide tax, legal, or accounting advice; prospective donors considering charitable giving should consult professionals in these fields.

Multigenerational Wealth Management: Getting a Legacy Up

37


r Value of the income tax deduction: A donor who funds a foundation during his life gets an income tax deduction for the gift. A foundation funded BUEFBUIQSPWJEFTOPJODPNFUBYEFEVDUJPO5IF portion of the deduction that can be used during life and the tax rate on the income it offsets are both important. r Potential impact on other wealth transfer objectives: Contributions to a foundation are irrevocable. Consequently, the donor is precluded from using those funds for other wealth transfer strategies like SPMMJOH(3"5TPSBOJOTUBMMNFOUTBMFUPBO*%(5 And since much of the wealth used for those strategies comes back to the donor, he might still give to charity annually during his lifetime and use some of his remaining assets to fund a foundation at his death. Accordingly, there is a potential opportunity cost to funding a foundation during life. 5PKVEHFUIFQSPTBOEDPOTPGQSFGVOEJOHBGPVOEBUJPO MFUTMPPLBUUXPBMUFSOBUJWFT r "EPOPSHJWFTNJMMJPOUPBGPVOEBUJPOEVSJOHIJTMJGFUJNF BOEJUQBZTPVUPGUIPTFBTTFUT each year to charity; or r 5IFEPOPSSFUBJOTUIPTFBTTFUT HJWFTPGUIFN FBDIZFBSUPDIBSJUZ BTIFXPVMEJGIFEFTUBClished a foundation), and leaves the balance to a foundation at his death.

*ODisplay 36 we analyze the merits of making a lifetime gift to the foundation. On the left-hand side, our analysis assumes that the donor is eligible for a deduction on the full amount of the contribution ($1 million), and that this amount can be used to PÄ&#x201E;TFUIJTPSEJOBSZJODPNF5IFHSBZMJOFFTUJNBUFT the value of accelerating the income tax deduction CZQSFGVOEJOHUIFGPVOEBUJPO5IFBEWBOUBHFJTWFSZ MBSHFJGUIFEPOPSEJFTFBSMZ*OUIFFYUSFNFDBTF  where his death comes soon after the contribution, he gets about $400,000 in tax savings from the upGSPOUHJGUUPUIFGPVOEBUJPOÂ&#x2021;GBSNPSFUIBOJGIFE chosen to make annual gifts to charity during that QFSJPE5IFSFBTPOJTUIBUBEPOPSXIPEJFTFBSMZ is unable to make enough gifts to realize a large income tax deduction. But the longer the donor lives, the more the advantage of accelerating the deduction diminishes, and eventually turns negative. 5IBUTCFDBVTFUIFEFEVDUJPOGSPNUIFHJGUUPUIF foundation, in this example, is limited to $1 million, XIJMFBEPOPSTBOOVBMHJWJOHPWFSBMPOHMJGFTQBO can amount to more than $1 million of gifts. Offsetting this declining benefit, however, is the massive additional buildup in wealth for charity BUUSJCVUBCMFUPUIFGPVOEBUJPOTUBYGSFFHSPXUI  JMMVTUSBUFECZUIFCMBDLMJOF5IJTCFOFĂŞUNPWFTJO the opposite direction of the value of the deducUJPOT*UTUBSUTPVUTNBMMBOEJODSFBTFTBTUIFCFOFĂŞU

Display 36

Now or later? The value of prefunding a foundation Ordinary Income Tax Deduction on Foundation Gift*

1.0

1.0 Tax-Free Growth

0.8

Tax-Free Growth

0.8

0.6

0.6

0.2 0.0

Accelerated Deduction

(0.2) (0.4) (0.6)

0.4 $ Mil.

Net Benefit of Foundation

0.4 $ Mil.

Capital Gains Deduction on Foundation Gift

0.2

Net Benefit of Foundation

0.0 (0.2) (0.4) (0.6)

0

5

10

15

20

Years Until Death

25

30

0

5

10

15

20

25

30

Accelerated Deduction

Years Until Death

*We assume an ordinary income tax deduction on all lifetime annual gifts made directly to charity. All accounts are invested in a mix of 80% globally diversified equities and 20% bonds. Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: AllianceBernstein

38

Bernstein Wealth Management Research


of higher tax-free growth compounds over time. All in all, prefunding the foundation yields significant value for all parties. As the bars indicate, the net benefit in the median case is about $400,000 at the TUBSU BOEBCPVU PWFSZFBSTPOBOJOĂŤBtion-adjusted basis. On the right of Display 36 we conduct the same analysis assuming that the donor is still eligible for UIFEFEVDUJPO*OUIJTDBTF IPXFWFS JUJTOUPSEJOBSZ JODPNFUIBUIFTMPPLJOHUPPÄ&#x201E;TFUCVUSBUIFSBTVCstantial capital gains tax from, say, the recent sale of a GBNJMZCVTJOFTT)FSFUIFCFOFĂŞUPGUBYGSFFHSPXUI to the foundation is the same as before (the black line), but the benefit of the income tax deduction UIFHSBZMJOF JTTNBMMFS*OGBDU UIBUiCFOFĂŞUuUVSOT OFHBUJWFNVDINPSFRVJDLMZ5IBUTCFDBVTFUIFSF is greater potential reduction in taxes by offsetting ordinary income in future years than realizing lower capital gains taxes now (eliminating a capital gains tax at about 20% will likely be less valuable than offsetting an ordinary income tax rate in the 40% range, even if the deduction is delayed). As a result, the overall benefit of prefunding a foundation is far MPXFSBUUIFTUBSUÂ&#x2021;BCPVU Â&#x2021;BOEJODSFBTFT only slightly over time.

*UTJNQPSUBOUUPVOEFSTUBOEUIFQSFDJTFSBOHFPG tax and other benefits that prefunding a foundation NBZPÄ&#x201E;FS*GUIFZSFTJHOJĂŞDBOUBOEUIFEPOPSIBT the excess capital to fund it, it may be a path worth UBLJOH)PXFWFS JGUIFJODPNFUBYTBWJOHTJTOPU very large, the donor might be better off using some PGUIPTFGVOETUPGVSUIFSMFWFSBHFUIFGBNJMZTXFBMUI transfer strategies and reduce their estate tax burden. 5IFRVFTUJPODPNFTEPXOUPUIJT4IPVMEUIFTFOJPS generation fully leverage wealth transfer strategies to further reduce the estate tax, or should they give greater priority to a charitable giving vehicle to maximize their potential income tax savings? *OUIFFOE BTVDDFTTGVMGBNJMZGPVOEBUJPONBZ help realize the highest objective of wealth transfer, wherein the value communicated to the chariUBCMFDBVTFJTDPJODJEFOUXJUIUIFGBNJMZTWBMVFT UIFNTFMWFT*UNBZSJQFOJOUPUIFUSVFNFBOJOHPGB legacy, whereby â&#x20AC;&#x153;the family changed its persons but not its manners, and they continued a blessing to the world from generation to generation.â&#x20AC;? â&#x2013;

39 Sarah Fielding, 5IF)JTUPSZPGUIF$PVOUFTTPG%FMMXZO, 1759

Multigenerational Wealth Management: Getting a Legacy Up

39


IMPLEMENTING, MONITORING, AND ADJUSTING THE PLAN

Over a three-year period, I gave away half of what I had. To be honest, my hands shook as I signed it away. Ted Turner

The Costs of Control

%FTQJUFLOPXJOHUIBUGPSHJOHBIFBEXJUIXFBMUI transfer is prudent, the senior generation may be SFMVDUBOUUPQVMMUIFUSJHHFS5IFZNBZCFOFSvous about their health or the uncertainties of the capital markets, they may fear that their spending needs will increase in the future, they may question whether the estate tax will be repealed, or they may be concerned about the deleterious effects that wealth transfer could have on their children or grandchildren. While the senior generation may value the comfort of retaining complete control of their funds, retaining such control for too long is likely to carry BTJHOJĂŞDBOUĂŞOBODJBMDPTU5IBUDPTUÂ&#x2021;JOUIFGPSN PGIJHIFSUSBOTGFSUBYFTÂ&#x2021;XJMMWBSZEFQFOEJOHPOB number of factors specific to each family, such as the TFOJPSHFOFSBUJPOTBHFTBOEMPOHFWJUZ UIFBNPVOUPG excess capital, and the wealth transfer strategies they plan to use to reduce their excess capital. Display 37 provides a rough qualitative guide to some of the drawbacks of delaying wealth transfer.

We can also provide some quantitative insight into UIFQPUFOUJBMDPTUPGEFMBZJOHXFBMUIUSBOTGFS*O Display 38, we project the wealth of a 60-year-old DPVQMFXJUITJHOJĂŞDBOUFYDFTTDBQJUBM5IFZIBWF NJMMJPO TQFOE BZFBS BOEBSFDPOTJEFSJOH NBLJOHHJGUTUP*%(5TGPSUIFJSGPVSDIJMESFOBOE six grandchildren and committing $20 million (or PGUIFJSUPUBMXFBMUI UPBSPMMJOH(3"5TUSBUFHZ4IPVMEUIFZJNQMFNFOUUIJTQMBO UIFZSFMJLFMZ to reduce their estates to their core capital someXIFSFBSPVOEUIFJSKPJOUMJGFFYQFDUBODZÂ&#x2021;BQBDF that they feel comfortable with. But if they wait ĂŞWFZFBSTCFGPSFJNQMFNFOUJOHUIJTQMBO UIFZMMHJWF up the benefit of those annual exclusion gifts, the benefit of the gift tax exclusion amounts growing outside their estates, and the buildup from the rollJOH(3"5TUSBUFHZ XIJDIHBJOTTUFBNBTUJNFHPFT PO5IFSFTVMUJTBNVDIMBSHFSDPNCJOFEFTUBUF  SFTVMUJOHJONJMMJPOJOBEEJUJPOBMFTUBUFUBYJOUIF median case. And the longer they wait, the more that cost grows; it swells to more than $20 million if UIFZXBJUVOUJMUIFZUVSOCFGPSFUIFZCFHJO

Display 37

The drawbacks of delay: Each strategy has its downsides Transfer Strategy

Potential Cost of Retaining Control

Annual Exclusion Gifts

Gifts are â&#x20AC;&#x153;use it or lose it,â&#x20AC;? so the cost is the estate tax on the forgone gifts and all the future unspent income and appreciation on the forgone gifts.

Gift Tax Exclusion

The $1 million gift tax exclusion can be used at any time, but delaying the gift wastes the opportunity to leverage it. The sooner it is used, the sooner the transferred assets can begin to grow outside of the grantorâ&#x20AC;&#x2122;s estate.

GRATs

The longer the donor delays a rolling GRAT strategy, the more heâ&#x20AC;&#x2122;ll need to commit to the strategy. Too long a delay may result in significant costs, since the strategy may no longer have the time to reduce the estate sufficiently.

Insurance

Delaying until the senior generation are older might result in higher premium costs; but more certain, and more damaging, is that an unexpected death (before a policy is secured) results in losing the entire death benefit.

Installment Sale to IDGT

The longer the donor delays a sale, the more heâ&#x20AC;&#x2122;ll need to commit to the strategy. And because the sale requires a minimum â&#x20AC;&#x153;seedâ&#x20AC;? gift to the IDGT, it may be impossible to scale up the sale sufficiently without the payment of gift tax.

Foundation

Each year that the funding is delayed is a lost year of virtually tax-free growth.

Source: AllianceBernstein

40

Bernstein Wealth Management Research


Display 38

Display 39

Delaying could result in higher estate taxes...

...or require a far greater commitment to GRATs to catch up

Senior Generation Wealth*

Senior Generation Wealth*

75

75

Delay 15 Yrs.â&#x20AC;

Delay 15 Yrs. 50

$ Mil.

Delay 10 Yrs. 25

Delay 5 Yrs.

Delay 10 Yrs.

$ Mil.

50

Start Now

Delay 5 Yrs.

25

Core Capital

Start Now

0 1

5

10

15

20

25

30

Core Capital

0 1

5

10

15

20

25

30

Years Median Cost of Controlâ&#x20AC; 5 years $ 5.2 Mil. 10 years 12.9 15 years 20.5

Percentage of Total Wealth Needed in GRAT 5 years 55% 10 years 90% 15 years N/A

* Typical markets; after spending, taxes, and inflation â&#x20AC; Mortality-adjusted; assumes 40% of capital committed to GRATs in each case, that spouses die in same year, that each has a remaining estate tax exclusion of $1 million, and that estates are subject to tax at a 45% rate. Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

*Typical markets; after spending, taxes, and inflation â&#x20AC; The display assumes 90% of assets contributed to GRATs at that time (Year 15). Based on Bernstein estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

1SPWJEFEUIFZEPOUEJFQSFNBUVSFMZ UIFZNBZCF able to catch up with the trajectory of the origiOBMQMBOÂ&#x2021;CVUPOMZJGUIFZSFNVDINPSFBHHSFTsive. For example, if they wait five years, they can get back on their transfer timetable if they increase UIFBNPVOUDPNNJUUFEUP(3"5TGSPNUP PGUIFJSUPUBMXFBMUIBUUIBUUJNF Display 39). 8JUIBZFBSEFMBZ IPXFWFS UIFZMMOFFEUPHFU SFBMMZBHHSFTTJWF TFUUJOHBTJEFPGUIFJSXFBMUIJO (3"5T"OEJGUIFZXBJUNVDIMPOHFSUIBOUIBU JUT VOMJLFMZUIBUUIFZMMIBWFUIFUJNFUPSFEVDFUIFJS estates to their core capital no matter what they do.

Revisiting and Adjusting the Plan

As this analysis indicates, the cost of the senior HFOFSBUJPOTSFUBJOJOHDPOUSPMDBONPVOUUPUIF QPJOUUIBUJUTJHOJĂŞDBOUMZFSPEFTUIFGBNJMZTXFBMUI 5IJTBXBSFOFTTTIPVMETQVSUIFTFOJPSHFOFSBUJPO to begin careful planning and take action. And if done properly, they can build enough flexibility into the plan so that any loss of control from the transfer of the funds out of their estates becomes a manageable concern.

*OGBDU BXFMMDSBGUFEXFBMUIUSBOTGFSQMBOMFBWFT ample room for the senior generation to make BEKVTUNFOUT8FCFMJFWFJUTDSVDJBMGPSBGBNJMZUP have a process for revisiting and changing the plan, because change may become necessary. For examQMF UIFGVOEJOHBNPVOUTXFWFCFFOEJTDVTTJOH are based on a very conservative determination of excess capital and anticipate the unlikely possibility of extremely bleak markets. *GUIPTFQPPSNBSLFUTGBJMUPNBUFSJBMJ[F XIJDI CZ definition, is highly likely), the senior generation will have the capacity to transfer even more wealth. *OGBDU JUNBZUVSOPVUUIBUUIFNBSLFUTBSFTP superior that they meet any specific wealth transfer goals far earlier than they expect. Of course, if their returns are so strong that they meet those goals RVJDLMZ JUTMJLFMZUIBUUIFJSDPSFDBQJUBMIBTQFSGPSNFEXFMM UPP*OUIBUDBTF UIFZMMĂŞOEUIFNTFMWFT with even more excess capital. Either way, revisiting the plan regularly is critical to its success. Multigenerational Wealth Management: Getting a Legacy Up

41


Display 40

Why itâ&#x20AC;&#x2122;s important to monitor and adjust the plan over time Plan Wealth (Start of Plan)

Reality Wealth (Year 10)

Goal

Tracking

Adjustment

Senior Generationâ&#x20AC;&#x2122;s Assets (Personal, GRATs)

$100 Mil.

$60 Mil. (in 10 yrs.)

$90 Mil.

Behind Schedule

Capacity to accelerate transfers Focus on dynasty trust/foundation

Childrenâ&#x20AC;&#x2122;s Assets (Personal, Grantor Trusts)

$5 Mil.

$50 Mil. (in 15 yrs.)

$50 Mil.

Ahead of Schedule

Increase target but reduce commitment to GRATs from $50 Mil. to $25 Mil.

Grandchildrenâ&#x20AC;&#x2122;s Assets (Grantor, GST Trusts)

$1 Mil.

$25 Mil. (in 25 yrs.)

$15 Mil.

Ahead of Schedule

Add $20 Mil. installment sale to dynasty trust (focus on great-grandchildren and beyond)

Foundationâ&#x20AC;&#x2122;s Assets

$5 Mil.

$5 Mil. (in perpetuity)

$8 Mil.

On Track

Add $20 Mil. in contributions over time

Source: AllianceBernstein

Display 40, right, and Display 41 describe the famJMZTBDUVBMFYQFSJFODFZFBSTJOUPUIFQMBO5IF senior generation still have substantial excess capital, the goal for the children has been met ahead of schedule, the goal for the grandchildren is tracking a bit ahead of schedule, and the foundation has more than preserved its purchasing power, even after making substantial distributions to charity. With this in mind, a change in the structure of the plan is in order. After a series of new projections, the family may make the following decisions:

Consider a hypothetical plan for a family where UIFTFOJPSHFOFSBUJPOIBWFNJMMJPO5IFQMBO is designed conservatively to ensure that the senior generation always have enough to support their TQFOEJOHOFFET UIBUUIFDIJMESFOIBWFBCPVU NJMMJPOBWBJMBCMFUPUIFNJOZFBST BOEUIBUUIF HSBOEDIJMESFOIBWFBCPVUNJMMJPOBWBJMBCMFUP UIFNJOZFBST$IBSJUZJTBMTPBOJNQPSUBOUQSJority, but the plan is to wait until the senior genFSBUJPOTEFBUITUPGVMMZGVOEUIFJSGPVOEBUJPO5IJT allows them to put more assets to work to transfer wealth to their descendants (see Display 40, left). Display 41

When markets outpace the plan Wealth per Generation in Year 10 $100 Mil. Estate Senior Generation

Children

100

80

$90 Mil. in Year 10

$ Mil.

75

40

60

Transfer Objective

25

20

10

0

0

Core 5

10 15 20 25 30 Years

Source: AllianceBernstein

Bernstein Wealth Management Research

15 Transfer Objective

40

$50 Mil. in Year 10

Charity 20

30

50

0

42

Grandchildren

20

10

$15 Mil. in Year 10

$8 Mil. in Year 10

5

Transfer Objective 5

10 15 20 25 30 Years

0 5

10 15 20 25 30 Years

5

10 15 20 25 30 Years


1.5IFZDBOBDDFMFSBUFUIFQBDFPGXFBMUIUSBOTGFSUP

reduce the potential estate tax burden. 2.5IFZDBODPOUJOVFUPNPWFNPOFZUPUIFDIJMdren (adding to their original wealth transfer goals), but will do so at a slower pace. 3.5IFZXJMMBDDFMFSBUFUIFQBDFPGXFBMUIUSBOTGFS to the grandchildren (and, perhaps, beyond) with BOJOTUBMMNFOUTBMFUPUIF(45FYFNQU*%(5 Specifically, they realize that they may want to provide for great-grandchildren or even more remote descendants. 4.5IFZDBOBDDFMFSBUFUIFQBDFPGUIFJSDIBSJUBCMF giving by making additional gifts to the foundation now, instead of waiting until they die. 5IFQPJOUJT JNQMFNFOUJOHBXFBMUIUSBOTGFSQMBO should not constitute a point of no return. A plan must be built with flexibility and revisited at regular JOUFSWBMTBTUIFTUSBUFHJFTFWPMWF UIFGBNJMZTDJScumstances change, and the capital markets inevitably fluctuate.

Display 42

The cycle of multigenerational wealth management Implement, Monitor, and Adjust Plan 1.

5.

Identify Core Capital and Allocate the Funds

Identify Strategies 4. to Move the Excess Capital

2. Size, Segment, and

3.

Allocate Excess Capital per Generation and Beneficiary

Determine the Timing of Wealth Transfer Source: AllianceBernstein

And as the senior generation take stock of the GBNJMZTDIBOHJOHXFBMUIQJDUVSFBOESFWJFXUIFJS goals, which may have evolved as well, the whole QSPDFTTTIPVMECFHJOBHBJO5IFTFOJPSHFOFSBUJPO must review their current and projected core capital OFFET5IFZDBOUIFOSFEFUFSNJOFUIFJSFYDFTTDBQJtal, assess the size and allocation of the individual buckets of assets for each generation and family member, decide whether to accelerate or decelerate the pace of wealth transfer, and determine whether the strategies they chose remain the best suited to achieve their goals. For that reason, true multigenerational planning must be understood as a regularly recurring, cyclical process (Display 42). â&#x2013;

Multigenerational Wealth Management: Getting a Legacy Up

43


APPENDIX 1. Core Capital Amounts for Couples Calculated at Different Asset Allocations 0%/100% Stocks/Bonds Age 50 Spending Rate* 2.3% Annual Budget $250,000 $10.9 $500,000 21.7 $750,000 32.6 $1,000,000 43.5 $1,500,000 65.2

55 60 65 70 75 2.5% 2.8% 3.1% 3.5% 4.1% Core Portfolio in $ Mil. $10.0 $8.9 $8.1 $7.1 $6.1 20.0 17.9 16.1 14.3 12.2 30.0 26.8 24.2 21.4 18.3 40.0 35.7 32.3 28.6 24.4 60.0 53.6 48.4 42.9 36.6

60%/40% Stocks/Bonds 80 85 4.7% 5.5% $5.3 10.6 16.0 21.3 31.9

$4.5 9.1 13.6 18.2 27.3

20%/80% Stocks/Bonds Age Spending Rate* Annual Budget $250,000 $500,000 $750,000 $1,000,000 $1,500,000

50 55 60 65 70 75 2.6% 2.8% 3.1% 3.4% 3.8% 4.4% Core Portfolio in $ Mil. $9.6 $8.9 $8.1 $7.4 $6.6 $5.7 19.2 17.9 16.1 14.7 13.2 11.4 28.8 26.8 24.2 22.1 19.7 17.0 38.5 35.7 32.3 29.4 26.3 22.7 57.7 53.6 48.4 44.1 39.5 34.1

50 55 60 65 70 75 2.8% 3.0% 3.2% 3.5% 4.0% 4.5% Core Portfolio in $ Mil. $8.9 $8.3 $7.8 $7.1 $6.3 $5.6 17.9 16.7 15.6 14.3 12.5 11.1 26.8 25.0 23.4 21.4 18.8 16.7 35.7 33.3 31.3 28.6 25.0 22.2 53.6 50.0 46.9 42.9 37.5 33.3

50 55 60 65 70 75 2.8% 3.0% 3.2% 3.5% 3.9% 4.4% Core Portfolio in $ Mil. $8.9 $8.3 $7.8 $7.1 $6.4 $5.7 17.9 16.7 15.6 14.3 12.8 11.4 26.8 25.0 23.4 21.4 19.2 17.0 35.7 33.3 31.3 28.6 25.6 22.7 53.6 50.0 46.9 42.9 38.5 34.1

80 85 5.1% 6.0% $4.9 9.8 14.7 19.6 29.4

$4.2 8.3 12.5 16.7 25.0

80%/20% Stocks/Bonds 80 85 5.1% 5.9% $4.9 9.8 14.7 19.6 29.4

$4.2 8.5 12.7 16.9 25.4

40%/60% Stocks/Bonds Age Spending Rate* Annual Budget $250,000 $500,000 $750,000 $1,000,000 $1,500,000

Age Spending Rate* Annual Budget $250,000 $500,000 $750,000 $1,000,000 $1,500,000

Age Spending Rate* Annual Budget $250,000 $500,000 $750,000 $1,000,000 $1,500,000

50 55 60 65 70 75 2.7% 2.9% 3.1% 3.4% 3.7% 4.2% Core Portfolio in $ Mil. $9.3 $8.6 $8.1 $7.4 $6.8 $6.0 18.5 17.2 16.1 14.7 13.5 11.9 27.8 25.9 24.2 22.1 20.3 17.9 37.0 34.5 32.3 29.4 27.0 23.8 55.6 51.7 48.4 44.1 40.5 35.7

80 85 4.9% 5.7% $5.1 10.2 15.3 20.4 30.6

$4.4 8.8 13.2 17.5 26.3

100%/0% Stocks/Bonds 80 85 5.2% 6.0% $4.8 9.6 14.4 19.2 28.8

$4.2 8.3 12.5 16.7 25.0

Age 50 Spending Rate* 2.5% Annual Budget $250,000 $10.0 $500,000 20.0 $750,000 30.0 $1,000,000 40.0 $1,500,000 60.0

55 60 65 70 75 2.7% 2.8% 3.1% 3.4% 3.9% Core Portfolio in $ Mil. $9.3 $8.9 $8.1 $7.4 $6.4 18.5 17.9 16.1 14.7 12.8 27.8 26.8 24.2 22.1 19.2 37.0 35.7 32.3 29.4 25.6 55.6 53.6 48.4 44.1 38.5

80 85 4.6% 5.4% $5.4 10.9 16.3 21.7 32.6

$4.6 9.3 13.9 18.5 27.8

2. Core Capital Amounts for Single Individuals (Male and Female) Calculated at 60/40 Stock/Bond Allocations Male 60%/40% Stocks/Bonds Age Spending Rate* Annual Budget $250,000 $500,000 $750,000 $1,000,000 $1,500,000

50 55 60 65 70 75 3.0% 3.3% 3.5% 3.9% 4.4% 5.0% Core Portfolio in $ Mil. $8.3 $7.6 $7.1 $6.4 $5.7 $5.0 16.7 15.2 14.3 12.8 11.4 10.0 25.0 22.7 21.4 19.2 17.0 15.0 33.3 30.3 28.6 25.6 22.7 20.0 50.0 45.5 42.9 38.5 34.1 30.0

Female 60%/40% Stocks/Bonds 80 85 5.7% 6.7% $4.4 8.8 13.2 17.5 26.3

$3.7 7.5 11.2 14.9 22.4

Age Spending Rate* Annual Budget $250,000 $500,000 $750,000 $1,000,000 $1,500,000

50 55 60 65 70 75 2.9% 3.1% 3.4% 3.7% 4.2% 4.8% Core Portfolio in $ Mil. $8.6 $8.1 $7.4 $6.8 $6.0 $5.2 17.2 16.1 14.7 13.5 11.9 10.4 25.9 24.2 22.1 20.3 17.9 15.6 34.5 32.3 29.4 27.0 23.8 20.8 51.7 48.4 44.1 40.5 35.7 31.3

80 85 5.5% 6.6% $4.5 9.1 13.6 18.2 27.3

*Spending is grown with inflation; spending rates assume maintaining spending with a 95% level of confidence. Based on Bernstein estimates of the range of returns for the applicable capital markets over the periods analyzed. Data do not represent past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System, pages 48â&#x20AC;&#x201C;49, for further details. Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

44

Bernstein Wealth Management Research

$3.8 7.6 11.4 15.2 22.7


3. Amount Transferred by Annual Exclusion Gift per Donee (in $ Thousands)*† Real Held in Grantor Trust Held in Taxable Trust

10% Confidence 50% Confidence 90% Confidence 10% Confidence 50% Confidence 90% Confidence

Nominal Held in Grantor Trust Held in Taxable Trust

10% Confidence 50% Confidence 90% Confidence 10% Confidence 50% Confidence 90% Confidence

5 Yrs. $85 64 49 $83 63 48 5 Yrs. $96 73 57 $92 71 55

10 Yrs. $233 150 100 $212 140 93 10 Yrs. $292 193 132 $265 179 124

15 Yrs. $452 266 162 $385 234 145 15 Yrs. $653 389 240 $554 341 215

20 Yrs. $790 421 236 $625 349 202 20 Yrs. $1,303 691 387 $1,034 575 333

25 Yrs. $1,265 628 326 $930 493 266 25 Yrs. $2,400 1,163 603 $1,763 908 496

30 Yrs. $1,953 906 437 $1,323 663 342 30 Yrs. $4,242 1,878 901 $2,878 1,382 704

20 Yrs. $6,883 3,043 1,390 $4,823 2,192 1,001 20 Yrs. $10,598 4,975 2,460 $7,397 3,578 1,780

25 Yrs. $9,534 4,010 1,748 $6,121 2,635 1,146 25 Yrs. $16,467 7,399 3,570 $10,489 4,856 2,368

30 Yrs. $13,214 5,312 2,192 $7,756 3,181 1,319 30 Yrs. $25,768 11,089 5,075 $14,835 6,620 3,116

25 Yrs. $8.34 3.22 1.22 $6.41 2.53 0.96 25 Yrs. $14.36 5.91 2.51 $11.03 4.65 1.97

30 Yrs. $12.09 4.55 1.72 $8.72 3.36 1.27 30 Yrs. $23.51 9.52 3.98 $16.75 7.03 2.98

4. Amount Transferred by $1 Million Gift Tax Exclusion (in $ Thousands)* Real Held in Grantor Trust Held in Taxable Trust

10% Confidence 50% Confidence 90% Confidence 10% Confidence 50% Confidence 90% Confidence

Nominal Held in Grantor Trust Held in Taxable Trust

10% Confidence 50% Confidence 90% Confidence 10% Confidence 50% Confidence 90% Confidence

5 Yrs. $2,204 1,322 789 $2,051 1,254 752 5 Yrs. $2,443 1,498 924 $2,272 1,419 880

10 Yrs. $3,452 1,744 887 $2,919 1,512 772 10 Yrs. $4,226 2,234 1,216 $3,567 1,936 1,061

15 Yrs. $4,910 2,300 1,099 $3,773 1,821 871 15 Yrs. $6,687 3,323 1,738 $5,133 2,632 1,385

5. Amount Transferred per $1 Million Contribution to Rolling GRATs (in $ Mil.)* Real Remainders Paid to Grantor Trust Remainders Paid to Taxable Trust

10% Confidence 50% Confidence 90% Confidence 10% Confidence 50% Confidence 90% Confidence

Nominal Remainders Paid to Grantor Trust Remainders Paid to Taxable Trust

10% Confidence 50% Confidence 90% Confidence 10% Confidence 50% Confidence 90% Confidence

5 Yrs. $0.98 0.30 0.02 $0.95 0.29 0.02 5 Yrs. $1.09 0.34 0.03 $1.06 0.33 0.03

10 Yrs. $2.21 0.78 0.21 $2.04 0.73 0.20 10 Yrs. $2.71 1.01 0.29 $2.48 0.94 0.27

15 Yrs. $3.68 1.40 0.48 $3.20 1.24 0.43 15 Yrs. $5.01 2.02 0.77 $4.34 1.79 0.68

20 Yrs. $5.70 2.19 0.81 $4.67 1.84 0.68 20 Yrs. $8.73 3.58 1.46 $7.12 3.01 1.23

*All assets are allocated 100% to globally diversified equities. †Starts at $12,000, grown with inflation in accordance with IRC § 2503(b)(2) Based on Bernstein estimates of the range of returns for the applicable capital markets over the periods analyzed. Data do not represent past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System, pages 48–49, for further details.

Multigenerational Wealth Management: Getting a Legacy Up

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Wealth Transfer Techniques Technique “Crummey” Power

Purpose A power in a trust that gives a beneficiary a lapsing right of withdrawal over contributions to the trust to qualify the contributions for the gift tax annual exclusion.

Description The trust instrument must provide the beneficiaries with powers of withdrawal over contributions to the trust, and the trustee must notify beneficiaries of their withdrawal powers, to qualify gifts for the gift tax annual exclusion.

Dynasty Trust

To transfer assets to multiple generations with the least possible transfer-tax cost, typically by combining gift or estate tax exclusion with GST-tax exemption.

Typically, the trust is designed to last for multiple generations and provide for discretionary distributions to family members.

Grantor Retained Annuity Trust (GRAT)

To transfer to beneficiaries a portion of the future return of an asset.

The grantor contributes assets to the GRAT. The grantor receives a fixed-dollar annuity from the GRAT for a number of years (the “annuity term”). After the end of the annuity term, the remainder typically passes to children or trusts for their benefit.

Installment Sale to Intentionally Defective Grantor Trust (IDGT)

To transfer to beneficiaries a portion of the future return of an asset.

Typically, the grantor makes a gift of at least 10% of the overall transfer to the IDGT. The grantor then sells the remainder of the assets to the IDGT in exchange for a promissory note bearing interest at a federally determined rate. The trust is designed to pass assets to the children or other beneficiaries.

Irrevocable Life Insurance Trust (ILIT)

To transfer to beneficiaries insurance-policy death benefits with low/no transfer-tax cost.

The grantor contributes assets to the ILIT, and the trustee purchases an insurance policy on the life/lives of the grantor and/or grantor’s spouse. Alternatively, the grantor may transfer an existing policy to the ILIT. The ILIT trustee owns the insurance policy and receives the proceeds upon the insured’s death, which may be held in further trust.

Family Limited Partnership (FLP) or Limited Liability Company (LLC)†

To consolidate management, investment, and disposition of assets in a single business entity, and transfer economic interests in the assets to younger generations.

One or more family members contribute assets to the FLP. The FLP has two classes of owners: general partners (GPs) and limited partners (LPs). GPs own controlling interests and bear FLP liabilities. LPs do not participate in management of the FLP and do not bear FLP liabilities. Depending on the restrictions in the partnership agreement and the nature of the assets contributed to the FLP, certain discounts may be appropriate in the valuation of LP units.

Private Foundation

To make gifts to charities in a tax-efficient manner. A donor can get an immediate income tax deduction for a gift to a foundation, even though the foundation may make grants to charities over multiple generations.

A private foundation is a tax-exempt organization to which a donor can make deductible gifts. A private foundation typically receives its funding from, and is controlled by, a single individual or family.

* If the trustee purchases the insurance policy, it is excluded from the grantor’s gross estate from the point at which the ILIT was created. If the grantor contributes

a preexisting policy to the ILIT, the policy will be excluded from the grantor’s gross estate beginning as of the third anniversary of the contribution.

† In many states a Limited Liability Company (LLC) is an alternative to an FLP. LLCs and FLPs have slightly different structures, but similar purposes and benefits.

46

Bernstein Wealth Management Research


Estate/Gift Tax Considerations Depending on the terms of the trust and the applicable circumstances, all or a portion of the value of the trust assets may be includable in a beneficiary’s estate at his death for estate tax purposes.

GST Tax Considerations Gifts to a trust with Crummey powers may or may not be subject to GST tax, depending on the terms of the trust. Allocation of GST-tax exemption may be necessary or appropriate for transfers to the trust.

Income Tax Considerations Income taxation varies, depending on the terms of the trust instrument. A trust with Crummey powers can be designed to be a grantor trust during the grantor’s lifetime.

Assets retained in the trust will not be subject to estate tax.

This trust is designed to be exempt from GST tax.

The trust can (but need not) be designed to be a grantor trust during the grantor’s lifetime.

The grantor can create a GRAT with no gift tax cost if the present value of the annuities equals the contribution. If the grantor survives the annuity term, any amount remaining in the GRAT passes to the remainder beneficiaries free of gift or estate tax. However, if the grantor dies during the annuity term, part or all of the trust assets are included in the grantor’s estate for estate tax purposes, reducing or eliminating the benefit of this vehicle.

Typically, not exempt from GST tax.

The GRAT is a grantor trust.

The initial gift to the IDGT is a taxable gift that requires use of the grantor’s gift tax exclusion, or, if none, payment of gift tax. The sale will not result in a taxable gift if the value of the promissory note equals the value of the assets sold and if the promissory note bears an interest rate sufficient to avoid an imputed gift.

This trust can be designed to be exempt from GST tax.

The IDGT is a grantor trust. Initial sale and interest payments to grantor are ignored for income tax purposes. If the grantor dies during the term of the note, the income tax consequences are uncertain, and capital gains tax may be due on the sale as of the grantor’s death.

Generally, the gift/sale assets are excluded from the grantor’s estate. If the grantor dies during the term of the note, the outstanding note balance is included in the grantor’s estate. Appreciation of trust assets exceeding the interest rate on the note passes to the remainder beneficiaries free of gift or estate tax. Typically, ILITs are designed to qualify annual contributions for the gift tax annual exclusion. A contribution to the ILIT exceeding the annual exclusion may result in a taxable gift that requires use of the grantor’s gift tax exclusion, or, if none, payment of gift tax.

This trust can be designed to be exempt from GST tax.

Typically, the ILIT is a grantor trust during the grantor’s lifetime and becomes a non-grantor trust upon the grantor’s death.

Any discounts properly reducing the value of LP units reduce the gift or estate tax exclusion used, or gift or estate tax paid, in transferring those units.

Any discounts properly reducing the value of LP units reduce the GST exemption used, or GST tax paid, in transferring those units.

FLP partners are taxed on their respective pro rata shares of income. Dispositions of partnership interests and the funding or dissolution of the FLP may trigger capital gains or other income tax consequences in certain circumstances.

Gifts to a foundation qualify for the estate and gift tax charitable deductions. The assets of the foundation are not includable in the donor’s estate for estate tax purposes.

A gift to a foundation is not subject to GST tax.

A private foundation is exempt from income tax. However, it must pay a small excise tax on its “net investment income,” which includes taxable bond interest, dividends, and capital gains. The tax is imposed at a rate of 1% to 2%.

The insurance policy is excluded from the grantor’s gross estate.*

Multigenerational Wealth Management: Getting a Legacy Up

47


NOTES ON WEALTH FORECASTING SYSTEM 1. Purpose and Description of Wealth Forecasting AnalysisSM #FSOTUFJOT8FBMUI'PSFDBTUJOH"OBMZTJTJTEFTJHOFEUP assist investors in making long-term investment decisions regarding the allocation of their investments among categories of financial assets. Our planning tool DPOTJTUTPGBGPVSTUFQQSPDFTT  $MJFOU1SPĂŞMF*OQVU UIFDMJFOUTBTTFUBMMPDBUJPO JODPNF FYQFOTFT DBTIXJUIdrawals, tax rate, risk-tolerance level, goals, and other factors; (2) Client Scenarios: in effect, questions the client would like our guidance on, which may touch on issues such as when to retire, what his cash-flow stream is likely to be, whether his portfolio can beat inflation long term, and how different asset allocations might JNQBDUIJTMPOHUFSNTFDVSJUZ  5IF$BQJUBM.BSLFUT Engine: a model that uses our proprietary research and historical data to create a vast range of market returns and that takes into account the linkages within and among the capital markets (not Bernstein portfolios), as well as their unpredictability; and, finally (4) A ProbBCJMJUZ%JTUSJCVUJPOPG0VUDPNFTPGUIFFTUJNBUFE ranges of returns and asset values the client could expect to experience, based on the assets invested pursuant to the stated asset allocation, are represented within BSBOHFFTUBCMJTIFECZUIFBOEQSPCBCJMJUJFT 8FPGUFOGPDVTPOUIFUI UI BOEUIQFSDFOUJMFT as representative of the upside, median, and downside DBTFT SFTQFDUJWFMZ)PXFWFS PVUDPNFTPVUTJEFUIJTSBOHF are expected to occur 20% of the time; thus, the range does not establish the boundaries for all outcomes. Expected market returns on bonds are derived taking into account yield and other criteria. An important assumption is that stocks will, over time, outperform long bonds by a reasonable amount, although this is in no way a certainty. Moreover, actual future results may OPUNFFU#FSOTUFJOTFTUJNBUFTPGUIFSBOHFPGNBSket returns, as these results are subject to a variety of economic, market, and other variables. Accordingly, the analysis should not be construed as a promise of actual future results, the actual range of future results, or the actual probability that these results will be realized. 2. Rebalancing Another important planning assumption is how the asset allocation varies over time. We attempt to model how the portfolio would actually be managed. Cash flows and cash generated from portfolio turnover are used to maintain the selected allocation among DBTI CPOET TUPDLT BOE3&*5TPWFSUIFQFSJPEPGUIF analysis. Where this is not sufficient, an optimization 48

Bernstein Wealth Management Research

program is run to trade off the mismatch between the actual allocation and targets against the cost of trading UPSFCBMBODF*OHFOFSBM UIFQPSUGPMJPXJMMCFNBJOUBJOFESFBTPOBCMZDMPTFUPUIFUBSHFUBMMPDBUJPO*OBEEJtion, in later years there may be contention between UIFUPUBMSFMBUJPOTIJQTBMMPDBUJPOBOEUIPTFPGUIFTFQBrate portfolios. For example, suppose an investor (in the top marginal federal tax bracket) begins with an asset mix consisting entirely of municipal bonds in his personal portfolio and entirely of stocks in his retirement QPSUGPMJP*GQFSTPOBMBTTFUTBSFTQFOU UIFNJYCFUXFFO stocks and bonds will be pulled away from targets. We put primary weight on maintaining the overall allocation near target, which may result in an allocation to taxable bonds in the retirement portfolio as the personal assets decrease in value relative to the retirement QPSUGPMJPTWBMVF 3. Expenses and Spending Plans (Withdrawals) All results are generally shown after applicable taxes and after anticipated withdrawals and/or additions, unless otherwise noted. Liquidations may result in realized gains or losses, which will have capital gains tax implications. 4. Modeled Asset Classes 5IFGPMMPXJOHBTTFUTPSJOEFYFTXFSFVTFEJOUIJTBOBMZTJT to represent the various model classes: Annual Turnover Rate

Asset Class

Modeled as...

Cash Equivalents

3-month Treasury bills

Intermediate-Term Diversified Municipal Bonds

AA-rated diversified municipal bonds of 7-year maturity

30

Intermediate-Term Taxable Bonds

Taxable bonds with maturity of 7 years

30

US Value Stocks

S&P/BARRA Value Index

15

US Growth Stocks

S&P/BARRA Growth Index

15

100%

Developed International Stocks MSCI EAFE Unhedged

15

Emerging Markets Stocks

MSCI Emerging Markets Index

20

Single Stock (Avg. Volatility)

Volatility: 40%; Dividend: 1.5%; Beta: 1.0

0

5. Volatility Volatility is a measure of dispersion of expected returns BSPVOEUIFBWFSBHF5IFHSFBUFSUIFWPMBUJMJUZ UIFNPSF likely it is that returns in any one period will be subTUBOUJBMMZBCPWFPSCFMPXUIFFYQFDUFESFTVMU5IF volatility for each asset class used in this analysis is listed under Assumptions (facing page *OHFOFSBM UXPUIJSET


of the returns will be within one standard deviation. For example, assuming that stocks are expected to return 8.0% on a compounded basis and the volatility PGSFUVSOTPOTUPDLTJT JOBOZPOFZFBSJUJTMJLFMZ that two-thirds of the projected returns will be between  BOE8JUIJOUFSNFEJBUFHPWFSONFOU bonds, if the expected compound return is assumed to CFBOEUIFWPMBUJMJUZJTBTTVNFEUPCF UXP thirds of the outcomes will typically be between (1.1)% BOE5IFTFSBOHFTBSFTMJHIUMZTLFXFESFMBUJWFUP what one might expect because the volatility calculation assumes the returns are log-normally distributed. #FSOTUFJOTGPSFDBTUPGWPMBUJMJUZJTCBTFEPOIJTUPSJDBM EBUBBOEJODPSQPSBUFT#FSOTUFJOTKVEHNFOU*UTIPVME also be noted that volatility varies in different time periods, particularly for inflation and fixed income assets.

9. Assumptions: Capital Markets Statistics

6. Technical Assumptions #FSOTUFJOT8FBMUI'PSFDBTUJOH"OBMZTJTJTCBTFEPOB number of technical assumptions regarding the future CFIBWJPSPGĂŞOBODJBMNBSLFUT#FSOTUFJOT$BQJUBM Markets Engine is the module responsible for creatJOHTJNVMBUJPOTPGSFUVSOTJOUIFDBQJUBMNBSLFUT5IFTF simulations are based on inputs that summarize the condition of the capital markets as of September 30, 5IFSFGPSF UIFĂŞSTUNPOUIQFSJPEPGTJNVMBUFE SFUVSOTSFQSFTFOUTUIFQFSJPEGSPN4FQUFNCFS   UISPVHI4FQUFNCFS  BOEOPUOFDFTTBSJMZUIF DBMFOEBSZFBSPG"EFTDSJQUJPOPGUIFTFUFDIOJDBM assumptions is available on request.

HF-Long/Short-High Volatility-Tax Aware (Current)

7. Tax Implications Before making any asset allocation decisions, an investor should review with his or her tax advisor the tax liabilities generated by the different investment alternatives presented herein, including any capital gains that would be incurred BTBSFTVMUPGMJRVJEBUJOHBMMPSQBSUPGUIFJOWFTUPSTQPSUGPlio, investments in municipal or taxable bonds, etc.

50-Year Median Annual 50-Year Mean Mean EquivGrowth Annual Annual 1-Year alent Rate Return Income Volatility Volatility Cash Equivalents

3.4%

3.5%

3.5%

0.7%

7.1%

Int.-Term Diversified Munis

4.5

4.7

4.4

4.6

5.6

Int.-Term Taxable Bonds

5.3

5.6

5.2

5.8

7.0

US Value Stocks

8.0

9.9

2.9

18.2

11.8

US Growth Stocks

8.0

10.2

1.6

20.0

13.8

Developed Intâ&#x20AC;&#x2122;l Stocks

7.8

10.8

2.9

22.2

13.1

Emerging Markets Stocks

6.4

11.4

2.6

27.7

21.3

Inflation

2.4

2.5

NA

1.5

7.0

Single Stock

3.6

10.0

2.0

38.7

32.9

11.6

13.4

2.5

18.6

30.1

6.2

6.5

3.5

7.2

20.2

HF-Market Neutral-Tax Aware (Current)

Based on 10,000 simulated trials, each consisting of 50-year periods. Reflects Bernsteinâ&#x20AC;&#x2122;s estimates and the capital markets conditions of September 30, 2007. Does not represent any past performance and is not a guarantee of any future specific risk levels or returns, or any specific range of risk levels or returns. For hedge fund asset classes, â&#x20AC;&#x153;Mean Annual Incomeâ&#x20AC;? represents income and short-term capital gains.

10. Mortality Mortality is modeled using our proprietary simulation model, which creates a range of death ages for a given BHFBOETFY5IFPVUDPNFTPGUIFNPSUBMJUZTJNVMBtion model are then combined with the outcomes of the Capital Markets Engine on a trial-by-trial basis to produce summarized mortality-adjusted results. Mortality simulations are based on the Society of Actuaries, Retirement Plan Experience Committee Mortality 5BCMFT31

8. Tax Rates* 6OMFTTPUIFSXJTFJOEJDBUFE #FSOTUFJOT8FBMUI'PSFDBTUing Analysis has used the following marginal tax rates: Federal State Federal Capital Qualified State Capital Start End Income Tax Gains Tax Dividend Income Tax Gains Tax Year Year Rate Rate Rate Rate Rate 2008 2010

35.00%

15.00%

15.00%

6.00%

6.00%

2011 2057

39.60

20.00

39.60

6.00

6.00

*Federal tax rates are blended with applicable state tax rates by including, among other things, federal deductions for state income taxes.

Multigenerational Wealth Management: Getting a Legacy Up

49


Selected Recent Bernstein Publications for Private Clients Full-Length Investment-Management Research

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â&#x2C6;&#x2122; The Enviable Dilemma:

â&#x2C6;&#x2122; Home-Country Bias: Where Traditional Asset Allocation Falls Short

â&#x2C6;&#x2122; The Last Risk Premium Standing â&#x2C6;&#x2122; Oilâ&#x20AC;&#x2122;s New Price/Demand Equation â&#x2C6;&#x2122; Research Innovation: Knowing Moreâ&#x20AC;Ś Using Knowledge Better

â&#x2C6;&#x2122; Saving for College: Putting 529 Plans to the Test

â&#x2C6;&#x2122; Structured Notes: Do They Live Up to Their Promise?

Concentrated Stockâ&#x20AC;&#x201D;Hold, Sell, or Hedge?

â&#x2C6;&#x2122; Hedge Funds: Too Much of a Good Thing?

â&#x2C6;&#x2122; Keeping It in the Family: Planning for Efficient Wealth Transfer

â&#x2C6;&#x2122; Looking Beyond Perpetuity: Customizing a Private Foundation

â&#x2C6;&#x2122; Managing Trusts: Better Decisions in an Uncertain World

â&#x2C6;&#x2122; The New Industrial Revolution: De-verticalization on a Global Scale

Special Topics in Investment Planning

Publications devoted to â&#x20AC;&#x153;demystifyingâ&#x20AC;? difficult planning issues, such as tax management, portfolio diversification, and market-timing strategies: â&#x2C6;&#x2122; Fortune & Misfortune: Investment Planning to Achieve One and Avoid the Other

â&#x2C6;&#x2122; The Importance of Managing Investment Taxes â&#x2C6;&#x2122; Market Timing: If It Feels So Rightâ&#x20AC;ŚHow Can It Be So Wrong?

â&#x2C6;&#x2122; The Role of Faith in Investing

â&#x2C6;&#x2122; Retirement: Plan Early and Often Please contact your Bernstein Advisor if youâ&#x20AC;&#x2122;d like more information on or a copy of any of these publications.


LWI was founded in 1985 to manage investments for individuals and families and is dedicated solely to investment research and management. Today, as a unit of LWI, we oversee some $109 billion* in private capital. Research is the basis of our ability to prudently manage the assets under our care; it is also the foundation of the full array of investment products, both global and local, that we offer. OUR CLIENT-CENTERED MISSION To have more knowledge and to use knowledge better than any other investment firm in the world To use and share knowledge to help our clients achieve investment success and long-term security To place our clients’ interests first and foremost

Research Excellence

Broad Array of Services

We believe that superior research is the ultimate source of superior investment returns and requires both knowing more and using knowledge better. Knowing more—having an information advantage over other market participants— requires doing deep fundamental and economic research on a truly global scale. Using knowledge better means identifying and exploiting pricing anomalies that can provide incremental return and employing portfolio-construction techniques to manage risk and return efficiently.

We offer value, growth, and style-blended stock portfolios across the global markets, real estate investment trusts, hedge funds, and taxable and tax-exempt fixed income portfolios—all actively managed.

With those goals in mind, we’ve built one of the largest and broadest research footprints in the business: 303 analysts* operating in 12 countries and covering thousands of securi ties in capital markets around the world. Our research effort is organized into separate groups dedicated to growth equities, value equities, fixed income, and real estate trusts, reflecting the unique needs of each investment approach.

Disciplined Investment Processes We leverage our research with systematic portfolio manage ment. Because our top investment management profes sionals determine the policies and make the decisions that underlie all our investment strategies, each client, regardless of account size, gets the very best our firm has to offer. These strategies and decisions are then further customized in relation to each account’s tax status and the client’s goals and circumstances. *As of December 31, 2009

Wealth Management Planning Because we recognize that private clients of very substan tial means have complex needs, we’ve created a team of people with expertise in a wide range of disciplines to counsel clients on sophisticated financial planning. Our wealth management professionals have experience in areas such as estate planning, intergenerational wealth transfer, philanthropy, alternative asset classes, liquidity events, and investment strategies for corporate executives. Working together with our clients’ other professional advisors and aided by a quantitative state-of-the-art wealth-forecasting tool, we stress-test multiple solutions to complex investment problems to help clients identify the strategies best suited to them financially and emotionally.

Client Service and Communications We recognize that client needs are varied. Our investment professionals seek to provide clients with the investment approach that is best for them, and they pride themselves on personalized and timely service. Further, our content-rich communications explain the research basis for our portfolio decisions, our analysis of recent market developments, and our market outlook, as well as other research findings.


March 2010

www.leaderworldinvestments.com

LWI  

LWI BLACK BOOK

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